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Poor performance by a fund is one of the key reasons many investors think of redeeming their money and investing it into another fund. And that makes sense. But before doing so, one must ensure that the fund is an underperformer and the fall or the problem of low returns isn't a generalised one across the funds of the same category.
While analysing any fund, consider the difference between a fund underperforming and a fund simply falling. For example, there can be situations when a fund falls by, say, 5 per cent, whereas the market falls by 10 per cent. Here the fund, in reality, has done well. There can be a possibility that your fund is providing negative returns, but it might be beating its benchmark and its peers across the category.
Also, the decision should not be based on near-term performance. It is important to experience a full market cycle. There are phases in the market when many funds do poorly, which is exactly why they also do very well in a reversal of the market. So, it is advisable to take a longer time frame to look at the real underperformance and act accordingly.
The most important thing to understand is that it is not the goal or the job of an equity fund to always generate returns, regardless of context. Each fund has a benchmark (generally a well-known stock market index), and technically the fund manager's job is limited to outperforming the index. If he does so on a sustained basis, he is entitled to feel that he deserves his salary and maybe a fat bonus too.
However, from the investor's point of view, a fund should also outperform most other funds of the same type. If a fund that was earlier an outperformer but starts underperforming other similar funds (its peers) on a sustained basis, say for a year to eighteen months, you should carefully consider it.
It's important to moderate one's idea of outperformance and underperformance. It is impossible to always be invested in the topmost fund of a category. There is always some up and down, even in the best funds. If you chase the absolute topmost fund, you are likely to do worse. A reasonable view is that you should choose a fund that spends most of its time in the top quartile (one-fourth of the number of funds in a category) with an allowance for some time in the second quartile. In a volatile and complex investment scenario, that's good enough.
And if you have carefully assessed all the parameters and are sure that the fund is an underperformer, switch to a different fund of the same category. While doing so, remember that whatever are the realised gains, they are liable to taxation. If you are selling it after a year (which should ideally be the case), gains only beyond Rs 1 lakh are taxable at 10 per cent. So if the gains are well within the exemption limit and you do not see yourself exceeding it in the financial year, it hardly matters when you make a move. Just try to keep the gap between redemption and re-investment as low as possible. However, if the realised gains are more than Rs 1 lakh, be mindful of the applicable taxes and plan accordingly.
This article was originally published on April 20, 2022.
Disclaimer: This content is for information only and should not be considered investment advice or a recommendation.
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