Finance

What to do with Underperforming Mutual Funds?

There are pros and cons to everything in life. Particularly with investments, if there is a possibility of making money then there is also a risk of losing money.

Over the years, investment instruments that minimize the risk of losing money have evolved a lot. However, not making as much money as anticipated is also a loss of expected earnings.

Compared to direct stock market investing, investing in mutual funds is relatively less risky. Furthermore, it is more lucrative than debt instruments, such as fixed deposits (FDs) or recurring deposits (RDs).

The volatility applies to mutual fund investments as these are subject to market risks. The fund corpus is either lent to businesses and governments as debt or invested in equities. There is always a certain level of risk involved. Experts recommend staying invested in funds for the long-term to earn consistent and maximum returns.

In difficult market conditions, it is possible that your mutual funds’ performances deteriorate. The challenge is identifying if and for how long the fund has been an underperformer. You must also try to determine if it is the appropriate time to quit the fund and invest in another scheme.

Performance monitoring

We all know that the equity market is a very volatile market wherein there are a lot of rags-to-riches and riches-to-rags stories. In either case, an important lesson is to monitor the performance of your investments on a regular basis and stay up-to-date with market conditions.

The first step is to analyze the fund performance over the last eight to twelve quarters. In order to know how your fund is performing, you need to compare this performance against the benchmark index. The benchmark index is the barometer of the market conditions and thus if your fund is performing better than its index, then there is nothing to worry about. If the performance of your mutual fund investments has been below the index only once in the previous four to six quarters, you must stay invested. However, if the fund has consistently underperformed for over three or four quarters you may consider an exit and reinvest your money in another fund.

If you consider comparing it against the category average then it is going to be extremely challenging, as the category classification depends on the different rating agencies. Furthermore, ensure you compare the right category of funds to make an intelligent analysis.

Make an Informed decision

As soon as you have discovered that your fund(s) have been underperforming, you need to start researching if it is the overall market that has slumped or is it particularly your fund. You should seek help from different resources, such as your broker, news, market reports, and investor network.

The underperformance could very much be a short-lived phase of the long-term investment instrument. Before taking any decision, you will need to research as much as possible and collect all the information that you can so as to make an informed decision.

It has been observed that the large-cap category has contributed most of the underperforming funds. Most of these have either had low assets under management (AUM) or a high expense ratio. Thus, it is advisable to invest in flagship schemes of the fund houses for maximum benefits.

The primary reasons because of which fund may underperform are:

  • Change of fund manager

The performance of the mutual fund scheme is a result of the fund manager’s investment acumen and style. It is not necessary that the new fund manager is not good if the fund is not performing, it could just be that the transition is taking a little longer and thus affecting the fund performance adversely.

  • Change of ownership of the mutual fund

Mergers and acquisitions are more frequent today than they used to be and the takeover of one fund by another or a merger of two funds puts the performance of the fund(s) in a very volatile state during the transition period. Once the transition is over the performance could get well back on track.

  • Expense ratio

It is the charge levied when you acquire mutual fund units. The ratio varies between 1.25% and 3%. Therefore, if the expense ratio is high, your returns are lower and vice versa. To maximize your returns, it is recommended you invest in funds that have low or no expense ratio.

Under no circumstances, you should choose to discontinue mutual fund investing. This is an investment instrument that has the most comfortable risk-return ratio and will definitely help you build wealth and achieve your future financial goals.

If the fund is managed by a reliable and experienced manager with a positive management style, there is a huge possibility that the fund’s performance will improve. Stay invested and tide through the short-term low-performance stage.