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Sunday, March 31, 2013

Sell Mutual funds that do not perform well

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More than 6,000 crore of investors' wealth is in 10 underperforming Mutual funds



Vaibhav Sharma is hoping that the mutual fund he invested in, in July 2007, will turn around some day and he will be able to recoup his money. The NAV of the SBI Infrastructure Fund (originally SBI Infrastructure Series 1) has never risen above its NFO price of 10 ever since it became open-ended in July 2010.


He is not the only one waiting for a miracle. Millions of people, who invested in the SBI Infrastructure Fund and other underperforming schemes, are making the same mistake. Even though these funds have underperformed their benchmark indices and their respective categories in the past 3-5 years, investors continue to cling on to these in the hope of better days ahead. More than 6,000 crore of investors' wealth is languishing in just 10 of these laggards (see table). An equal amount may be stuck in scores of smaller funds that have not generated significant returns for investors in the past 5-6 years.


It's something that market regulator Sebi is also concerned about. It has pulled up fund houses for the underperformance and even hinted at stricter norms for laggard funds. It wants to know why these underperforming schemes should charge an expense ratio if they have failed to generate even the same returns as their benchmark indices.


As far as underperformance goes, infrastructure funds are the biggest villains. To be fair, the sector has performed poorly in the past 5-6 years, which is reflected in the poor returns of infrastructure funds. However, some schemes have managed to buck the trend. The Franklin Build India Fund, for instance, has churned out a return of 17.5%, even as the average fund has lost 2.2% in the past year. However, critics point out that some infrastructure schemes have done well largely because they have invested in non-infrastructure stocks as well. They should not be seen as thematic funds but quasi-diversified schemes.


If the infrastructure sector has not done well, does it make sense to remain invested in it? After all, the CNX Infrastructure index has fallen nearly 11% every year in the past five years. Shifting out when the sector is at a low can be risky because you may end up redeeming at the bottom. We see better days ahead for the infrastructure and capital goods sectors.


While patience is certainly a virtue when it comes to equity investing, it should not mean that investors lose sight of their funds' performance compared with their peers and the broader market. Choosing a good fund with a brilliant track record doesn't imply that your work has ended. In 2007, Reliance Vision was among the most highly recommended diversified equity funds. Today, it is floundering, having consistently underperformed its benchmark in the past 1, 3 and 5 years.


They should also remember that there is a fundamental difference between exiting an underperforming fund and selling a loss-making stock. A stock may be down because of a number of reasons—fundamental, technical and sentimental. If the fundamentals are intact, any dip in the price is likely to be short lived and the stock will eventually bounce back. If you sell a stock when it is down and reinvest elsewhere, you could miss out on the gains when it rebounds. Besides, there is no guarantee that the scrip in which you reinvest the proceeds will also rise. It could be a double whammy if this scrip falls even as the stock you had exited takes an upward trajectory.


However, none of this applies when you move out of an underperforming mutual fund. If it has been consistently lagging the benchmark and category, it is time to get rid of it and shift to another scheme. If you transfer the investment to another plan, you will not miss out on the gains when the market moves up. In fact, there is a greater chance that a good scheme will outperform the market while the laggard will fall behind. So, dispose of the loss-making investment before you pile up further losses.

Happy Investing!!

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