How to handle Mutual Fund Underperformers

After spotting mutual fund underperformers in the portfolio, what is the next step? The options may seem quite obvious and there is not much to write about. I decided to write a post about it (instead of mentioning this in the last post itself) for two reasons:

  1. Handling underperformers in the portfolios has some interesting aspects of investment risk.
  2. Ashal Jauhari's standard answer to this topic is deeply insightful and deserves some spotlight.

Now, let us assume that there is a fund we have an SIP running in, for say the last 4 years. we ae not satisfied with it and would like to shift our SIP to another fund that has been shortlisted.

A question that many investors ask, 'how should I shift? What should I do with my old units?'

Ashal's brilliant answer to this question is, "you are merely changing trains. Therefore, redeem all existing units and invest in the new one shot and start a new SIP there".

It is brilliant not only because it is easy to understand, but also  it is one of the very few succinct, yet eloquent, textual description of investment mathematics.

Ashal often likes to say that his recommendations are not 'mathematical' like mine. He is not often wrong, but he is here. Pretty much every recommendation of his is soaked in mathematical logic.

Take the train analogy above. What is meant by changing trains here? We are shifting from one asset class to another. The risk has not changed. The day before we switched, a lump sum (our existing units) was invested in the old fund exposed to the full volatility of the market.

Remember, that SIPs do not reduce the risk of the total investment made. It merely averages the entry price of the next instalment. Trivia: A good 49 equity funds (excluding sector funds) have  single-digit 10-year SIP returns. SIP is only a method of buying fund units. It is important to not get married to our SIPs.

Now back to the train analogy. Assuming the new fund also belongs to the same asset class, we are going to start an SIP in it. Why not shift all old units to the new fund in one shot? Are we going to lose anything by doing that? The underlying market risk has not changed. The 'we are merely changing trains' response bring this point out beautifully.

The reason this simple point requires elaboration is because not many are comfortable doing this. They believe that the lump sum must be gradually shifted. Why? Because it is a lump sum? It is not just a lump sum. It is a lump sum already in the market!

So there are now two choices: (a) switch in one-shot and start SIP in the new fund or (b) leave alone old units and start SIP in the new fund.

Option (b) is probably a guaranteed road to portfolio clutter!

Perhaps many may not agree with me, but I feel that starting out with an ELSS mutual fund for tax saving tends to clutter the folio. By the time they no longer need the 80C break, the folio of many already has 2/3 ELSS funds - 'hot' funds collected year after year. Then new non-ELSS funds are added while the ELSS funds stay back in the folio for years.

I feel it is better to use instruments like PPF for tax saving after accounting for tax saving expenses like  term life covers, children's tuition fee, home loan principal. Then if there is room, use PPF as part of a diversified portfolio. This again is Ashal's idea: Making the best use of section 80C for tax saving: an example.

The same arguments also apply to those who would like to reduce the number of funds in the folio with the sole aim of reducing clutter? Just do it!

In case you are wondering who Ashal Jauhari is, he is the administration of Facebook group, Asan Ideas of Wealth. You can know more about here: Interview with Ashal Jauhari: Relentless Financial Awareness Activist

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13 thoughts on “How to handle Mutual Fund Underperformers

    1. freefincal

      Yes of course. Since the old fund should be given at least 3-4Y to perform, much of the amount would be free from both.

      Reply
    2. ASHAL JAUHARI

      Dear Ajeesh, one may consider those things but at the end of the day, you are dumping the fund for underperformance. STCG for units of less than 1Y may or may not be there. Exit load is also individual fund based thing. Some do have exit loads upto 2Y time frame.
      So what's the solution?
      RIPFPI.

      Thanks

      Ashal

      Reply
  1. Ankit

    Its brilliant way to explain the next steps to be taken once you have identified Underperformers. Analogy is simple to remember and yet powerful. Thank you Pattu sir and Ashal sir for the insightful post as usual.

    Reply
  2. Kunal

    Thanks for a timely post. Was confused between a monthly SWP or one shot withdrawal. This helps. My fund is now 4 years old with me and have given a decidedly lower performance as per ValueResearch. Will now do as suggested as it also makes sense - why to persist with an underperformer any more?

    Reply
  3. R SIVA PRASAD

    It is easy to shift to new fund of same AMC. But to another AMC, we have redeem , wait for credit to your bank account (2 or 3 days), then purchase units of new fund. Within 3 days, market fluctuations may be high or significant to consider. Am I right sir?
    Thank You

    SIVA PRASAD
    KHAMMAM

    Reply
  4. Jayadeep Purushothaman

    I did just that(lumpsum shift) in the past few weeks, few were from ULIPs, some from brokered ones to direct ones. I was also thinking whether I should do slowly, but then the funds are already in the train, why worry!

    The value from this blog for me has been the insights that are thoroughly backed up by data which has enabled me to take decisions on my own for investing. I used to be a Performance Engineer for computer systems deployed by a computer major on the field. So typically, you don't get too much time to analyze, but without the insights and data, you may be making a bad call. We had some fantastic tools to do that like you are doing with your tools.

    Than you Pattu!

    Reply

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