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When should you sell a poorly performing fund?

The Fund Ratings tells you how a fund has performed on a risk-adjusted basis relative to a relevant category in the past


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One of the main purposes of monitoring your investment portfolio is to identify the bad guys and throw them out. There is also the attendant question of getting the good guys in, but that comes later. When equity markets are doing badly for an extended period of time, it is easy to find fault with how most funds are doing. But identifying funds that are the real dogs is a little more complex than that.

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In bad times, fund managers get really tested because that is also the time when it is easiest to misidentify reasonable performance as something bad. Instead, we need to consider in what sense a fund has performed poorly. There are three or four types of poor performance that we should distinguish between. First, there is absolute returns. Clearly, an equity fund that has had returns of say, 5 per cent per annum over the past five years hasn't even kept up with a bank deposit. So an easy conclusion would be that such a fund has done badly. However, that may or may not be true.

While a fund may be disappointing in terms of absolute returns, there are other questions that are more important. For instance, how has the fund done compared to its peers? Is it higher or lower than the average of its category?

Now this is something you can easily find out if you tracked your portfolio on the Value Research website. Here you can also check how the fund has performed in comparison to its benchmark index.

Apart from this, there are a variety of statistical measures that can tell you how the funds in your portfolio are doing. However, this can very quickly become too complex if you are not used to doing this kind of research. Instead, use a single measure that encompasses these attributes to find out whether your fund's performance is adequate.

The Star Rating of a fund that Value Research updates every month provides such a measure of performance. The Fund Ratings tell you how a fund has performed on a risk-adjusted basis relative to a relevant category in the past. This way it balances both risk and return. The fund rating is a good starting point for fund evaluation.

As a general rule of thumb, you should be invested only in five star and four star funds. If a fund's rating drops one step, treat that as a warning; and if it drops two points, then you must pull out of it and shift the money into a five star fund of the same type. Of course for tax reasons, you shouldn't sell out of investments that have been held for less than one year. But don't worry - funds rarely see such a rapid change in their ratings.

The bottom-line is that when you monitor your portfolio for funds that aren't doing well, then instead of the bare returns, a composite measure like the Value Research Star Rating gives you the real picture.

This article first appeared in October 2013.

 
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