How to spot & handle Mutual Fund Underperformers

In a two-part series, I would like to discuss how to spot (I) and how to handle (II) mutual fund underperformers. I write this after suggestions on twitter and by Kunal Lal.

|amp|

The first step is to define underperformance. This is possible only if the right category of mutual funds is first selected for investment. Most investors do not do that. AMCs offers incorrect suggestions regarding investment durations and I have little confidence is the levels of understanding about investment risk among the ‘advisor’ community.

If I choose an equity fund and expect 15% return every year or 25% return after 3 years, the fault lies with me. I have discussed investment risk in multiple posts before and do not wish to do so again. Interested readers may consult: Equity investing: How to define ‘long-term’ and ‘short-term’.

|amp|

Low expectation, not just reasonable, is the key to investment success. Especially for those who do not wish to understand how market fluctuations can be measured.

The second step is to ask, what is the role of a fund manager?

The fund manager of an actively managed portfolio has only one goal, beat the benchmark index. If the fund management starts to worry about star ratings, it is a sign that they have no process in place.

If possible, the benchmark for comparison should be the total returns index and not the price index. Here is an example: Sensex Total Returns Index as a Mutual Fund Benchmark.

Many fund managers manage to beat the benchmark by allocating stocks from outside the index (style impurity). This is an unhealthy sign of outperformance. Not easy to spot, more on this later.

The third step is to ask, ‘how long am I willing to give the fund manager time to beat the benchmark?‘.

If your answer is one year, I suggest you stick to index funds! I would recommend at least 3 years and a maximum of 4/5 years. My goals are decades away. So I have no problem with 5 years.

The outperformance should be consistent.

Before investing: the fund should have bet the index for most of the every possible 3/5 year period, say for the last 10Y. This can be evaluated using

Mutual Fund SIP and Lump Sum Rolling Returns Calculators

After investing: Give it at least 3 years to beat the index (total returns).

Beating the index cannot always mean spectacular outperformance. Sometimes, it can be less than 1%. It depends on too many factors: age of the fund, investment style, market movements etc.

If this has not happened, the reasons must be investigated. What kind of market are we in now?

Have funds with the same benchmark managed to beat the index? If I look at the rolling returns graphs, do I see a dip in performance?

How has the fund figured in your portfolio? What is the XIRR of the fund vis-à-vis the portfolio XIRR?. Read more:

How to review a mutual fund portfolio

How to Review Your Mutual Fund SIPs

Then the key question, ‘do you think the fund will recover?‘. This is a difficult question to answer and one needs to look at the stock portfolio.If you have faith, continue, else chuck it.  I will discuss how to handle underperformers in the next post.

If I have enough expertise to do that, why would I choose mutual funds? There is also no way of knowing if an  ‘advisor’ has such expertise.

If you are someone like me, incapable or uninclined of answering the above question, sticking to it if you have faith, else chuck it.

|amp|

What matters is the ability to gauge the present health of our investment portfolio, not the future health of a mutual fund portfolio.

Part II: how to handle underperformers

Caution:

  1. Ignore opinions about the fund manager: ‘why did he pick this’, ‘why is holding on to this’ etc.
  2. Do not seek random opinions about what to do! Eg. from star ratings, Asan Ideas for Wealth etc.
  3. Having low expectations. This guarantees minimum disappointment and minimum portfolio management.
  4. Do not ditch your funds in favour of a fund that ‘everyone is talking about’

Announcement: Travel to Europe at 40-50% lower air fares!!
Pranav Surya just posted in AIFW that “Oman Air + Lufthansa are running a fantastic promotion for cities to travel from Delhi”. If you want to avail such huge discounts (eg. Delhi to Berlin only Rs. 23K) , follow the steps pointed out in our new book: GameChanger (Rs. 199 hardcover; Rs. 99 Kindle). Additional tips are available in the Travel Training Kit (Rs. 199)

Ask Questions with this form

And I will respond to them coming Monday. I welcome tough questions. Please do not ask for investment advice. Before asking, please search the site if the issue has already been discussed. Thank you.  PLEASE DO NOT POST COMMENTS WITH THIS FORM it is for questions only.

GameChanger– Forget Startups, Join Corporate & Live The Rich Life You want

My second book, Gamechanger: Forget Start-ups, Join Corporate and Still Live the Rich Life you wantco-authored with Pranav Surya is now available at Amazon as paperback (₹ 199) and Kindle (free in unlimited or ₹ 99 – you could read with their free app on PC/tablet/mobile, no kindle necessary).

It is a book that tells you how to travel anywhere on a budget and specific investment advice for young earners.

GameChanger review 4 650x477 - How to spot & handle Mutual Fund Underperformersboth covers 650x467 - How to spot & handle Mutual Fund Underperformers

The ultimate guide to travel by Pranav Surya is a deep dive analysis into vacation planning, finding cheap flights, budget accommodation, what to do when travelling, how travelling slowly is better financially and psychologically with links to the web pages and hand-holding at every step.  Get the pdf for ₹199 (instant download)

You can Be Rich Too with Goal-Based Investing 

My first book with PV Subramanyam helps you ask the risk questions about money, seek simple solutions and find your own personalised answers with nine online calculator modules.

mini Final cover - How to spot & handle Mutual Fund Underperformers

You can be rich too Review1 650x254 - How to spot & handle Mutual Fund Underperformers

The book is available at:

Amazon Hardcover Rs. 271. 32% OFF

Infibeam Now just Rs. 270  32% OFF. If you use a mobikwik wallet, and purchase via infibeam, you can get up to 100% cashback!!

Flipkart Rs. 279. 30% off

Kindle at Amazon.in (Rs.271) Read with free app

Google PlayRs. 271 Read on your PC/Tablet/Mobile

Now in Hindi!

Hindi You can be rich too - How to spot & handle Mutual Fund Underperformers

Order the Hindi version via this link

Create a "from start to finish" financial plan with this free robo advisory software template


Free Apps for your Android Phone

Install Financial Freedom App! (Google Play Store)
Install Freefincal Retirement Planner App! (Google Play Store)
Find out if you have enough to say "FU" to your employer (Google Play Store)

About Freefincal

Freefincal has open-source, comprehensive Excel spreadsheets, tools, analysis and unbiased, conflict of interest-free commentary on different aspects of personal finance and investing. If you find the content useful, please consider supporting us by (1) sharing our articles and (2) disabling ad-blockers for our site if you are using one. We do not accept sponsored posts, links or guest posts request from content writers and agencies.

Blog Comment Policy

Your thoughts are vital to the health of this blog and are the driving force behind the analysis and calculators that you see here. We welcome criticism and differing opinions. I will do my very best to respond to all comments asap. Please do not include hyperlinks or email ids in the comment body. Such comments will be moderated and I reserve the right to delete the entire comment or remove the links before approving them.

3 thoughts on “How to spot & handle Mutual Fund Underperformers

  1. I have a bad performer. checked with Value research, and found a better performer in the peer group. No SIP, only lump sum switch.
    1) Do you advice jump to new AMC or a better performer in the same AMC. 2) How many max AMCs one can have in his portfolio.
    3) How much max amount one can have in one AMC.
    These are the general doubt any body can have after reading your articles.

    1. A portfolio should have min of funds per goal. So not more than 2/3 amcs. If you find a good fund in the same amc, not harm in switching. Max amt in same amc is a matter of personal comfort.

Do let us know what you think about the article