Triggers for exiting your mutual fund investment

Topics Covered

• 1. When the funds you hold are adding risk to your portfolio
• 2. When the funds you hold are constant laggards on investment performance
• 3. When your sector and theme preferences are losing steam
• 4. When equity as an asset class comes into question

1. When the funds you hold are adding risk to your portfolio

How do you react when you believe that your fund holding is adding risk to your portfolio? Let us take the case of JP Morgan Debt scheme which was overexposed to one single stock - Amtek Auto. This is a classic case of the fund overexposing your money to the vagaries of a single company. You should view such funds with suspicion. The moment you feel that a fund manager is adding to your risk in the process of managing your money, it is time to rush for the exit. Of course, this is a problem with a single AMC; not with mutual funds as a whole. You can always come out of that particular AMC scheme and shift to another similar scheme with a higher risk aversion. This way, your long-term goals will not be impacted. A fund manager’s job is to enhance returns and de-risk your portfolio. The moment you feel that your fund manager is adding risk; it does not make sense to continue with the fund.

2. When the funds you hold are constant laggards on investment performance

As we said earlier, your fund manager's job is to reduce risk and enhance returns. You obviously do not want to be stuck in a fund that is a consistent underperformer. When 70% of the equity funds outperform in a bull market, there is no reason why your equity fund should perform below the index returns. Occasional blips in performance are understandable. But consistent underperformance normally hides a larger story. The fund manager may be too conservative and hence he is sticking to safe laggards. You surely do not need a fund manager to do that. Secondly, the fund’s corpus could be too small or redemption pressures may be too high. It is also possible that your fund manager has got its view on the market entirely wrong and is in the wrong place at the wrong time. Remember, even a consistent 1% outperformance can have a large impact on your future wealth if compounded over a long period of time.

3. When your sector and theme preferences are losing steam

This is applicable when your holdings include funds that are designed to benefit from specific themes and sectors. Technology funds, pharma funds, infrastructure funds, dividend yield funds, mid cap funds are all cases in point. It is very important that when you hold thematic and sector funds, you understand and track these themes and sectors very closely. Take the case of infrastructure funds. Had you bought these funds in 2006, you must be still sitting on a massive NAV depreciation as most of these stocks are still quoting at a fraction of their 2006-07 prices.

When you invest in sector funds, always keep an eye on valuations. Buying an IT fund at the peak of the dotcom boom in 1999 when IT stocks were quoting at 100 times earnings is crazy. By 2001, most of the technology funds were quoting at 10% of their par value. That was the time to accumulate. Remember, when you buy sector funds you have to be opportunistic. When you feel that the sector story is running against a wall or valuations are too steep, just exit those sector funds.

Thematic funds are slightly more complicated as it becomes hard to measure them. For example, a dividend yield story makes sense when valuations are low and dividend payouts are generous. You can never apply that theme at the peak of a bull market. Take the case of a mid-cap or small-cap theme. Such themes work best in the period when bull markets are being built. In a falling market, mid cap themes can be disastrous as they tend to underperform the markets by a huge margin.

4. When equity as an asset class comes into question

People who bought mutual funds at the market peaks of 2000, 2007 or 2010 are rarely a happy lot. Remember, all these peaks gave sufficient indications well in advance. The valuations were too high, quarterly numbers were weak and there was a surge of retail interest. When you see these indicators, the question is what should you do? There are no easy answers but some pointers can help.

If you find that market valuations are getting closer to peak valuations and earnings are not matching, it is time to undertake a strategy shift. You can switch your equity funds to debt funds or liquid funds and wait for better valuations. In the process, you can ensure that you are sufficiently liquid when markets offer cheaper valuations. Shifting to debt funds or even liquid funds when equities are at crazy valuations is actually a very sensible idea.

This brings us to the million-dollar question -How do investors recognize that it is time to get out of equities and park your funds in debt? There are no hard and fast rules but valuation comparisons can give tremendous insights and they are rarely wrong. Of course, do not forget to consult your financial advisor and get a real-time perspective on your portfolio strategy. The moral of the story is that there is nothing sacrosanct about your holdings in mutual funds. Once you are convinced that a shift out is warranted, ask yourself two simple questions: 1. Will this MF exit negatively impact my long term goals? 2. Can this money be put to better use? If your answer to the first question is “no” and to the second question is “yes” just go ahead and exit. You are on the right track!