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.
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’.
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:
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.
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
- Ignore opinions about the fund manager: ‘why did he pick this’, ‘why is holding on to this’ etc.
- Do not seek random opinions about what to do! Eg. from star ratings, Asan Ideas for Wealth etc.
- Having low expectations. This guarantees minimum disappointment and minimum portfolio management.
- 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 want, co-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.
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.
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!
Order the Hindi version via this link
Connect with us on social media
- Twitter @freefincal
- Subscribe to our Youtube Videos
- Posts feed via: Feedburner
- We are also on Google Plus and Pinterest
Do check out my books
My first book is now available at a 35% discount for Rs. 258. It comes with nine online calculators. Get it now . The Kindle edition is only Rs. 199.
Gamechanger: Forget Startups, Join Corporate & Still Live the Rich Life You WantMy second book is now only Rs 199 (Kindle Rs. 99) Get it or gift it to a young earner
The ultimate guide to travel by Pranav SuryaThis 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)
Free Apps for your Android PhoneAll calculators from our book, “You can be Rich Too” are now available on Google Play!
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)