Many mutual fund investors tend to think that once they have bought a fund, they can stay invested in it forever and wealth creation will just happen. Alas, not all funds are meant as a lifetime investment. You must review your fund's performance periodically and decide whether it is doing well or not. While not every bit of bad news should get you worked up, here are some situations when you may consider exiting a fund.
If a fund has been consistently underperforming in its category, or even worse its benchmark, this is definitely a red flag. However, you shouldn't exit a fund just because it underperforms in the short term. Even good funds that have outperformed for decades can face temporary setbacks. In such cases, stay invested and wait for a recovery.
You may use Value Research's star ratings to assess a fund's performance. Do this by looking up your fund in the search bar at the top of the site. On your fund's page, you will find the VR star rating right next to the name of the fund, with ratings ranging from 1-star to 5-star. The exception is when a fund hasn't been around long enough for its performance to be evaluated, in which case there will not be any rating.
Change in mandate
You may want to exit your fund if it changes its market-cap orientation or its investment style. For instance, if you invested in a multi-cap fund which is now operating as a mid-cap fund, consider quitting it if you did not bargain for the added risk this entails. Similarly, a change to a debt fund's fundamental attributes so that it invests more in lower-rated securities may necessitate an exit.
Change in fund manager
No matter what fund houses say about their process-driven approach and how it renders any change in fund manager inconsequential to the performance of the fund, the truth remains that fund managers have a decisive impact on fund performance. If there is a change in fund manager, you really do want to keep a close watch on the fund.
Change in ownership
Fund houses have their own investment culture, which gets reflected in their stock picks. If a fund house is acquired by another one, its investment philosophy is likely to be impacted. If this happens, keep your eyes peeled for any significant developments in how your fund is being managed.
Overlap in holdings:
Let's say you own two funds with a significant overlap in stock holdings. Here you may want to sell one of them because you are not achieving the optimum level of diversification.
You may also want to sell funds if you have too many in your portfolio. It is alright to have around five well-picked funds in a portfolio to attain diversification. But anything more than that increases the complexity of your portfolio without necessarily benefitting you.
If the goal for which you invested in the mutual fund in the first place is close at hand, you may want to liquidate your investments in the fund. Or you may want to transfer the corpus from an equity to a debt fund. Ideally, use a systematic withdrawal plan (SWP) or a systematic transfer plan (STP) to exit the fund. This helps protect you from a market downturn.
If you realise that you want to exit a fund for any of the above reasons, by all means do so, as long as there is evidence that justifies your decision. But whatever you do, do not sell a fund simply because of handsome short-term gains. Held for the long term, equity funds have the potential to grow your money manifold. If you sell too early, you not only miss out on those gains, but your goal planning may also suffer as a result.