Evaluating individual fund: Base decisions on 8 quarters of performance

During her annual portfolio review, Mignonne D’Souza (name changed on request), a 44-year-old content writer based in Mumbai, found that four of her seven mutual funds had outperformed, while three lagged behind their benchmarks. D’Souza is wondering if she should stick to these funds or exit them. 

The Sensex began the year at 72,240 and closed at 79,218 on December 19, 2024. While the rising tide boosted most funds, some have not delivered. However, underperformance does not automatically warrant a sell decision. 

Evaluation criteria 

Consider multiple performance metrics. First, review trailing returns over various horizons, giving greater weight to longer-term performance. Second, look at calendar year returns to determine consistency. Third, examine three- or five-year rolling returns for a comprehensive view. Compare the fund’s performance against its benchmark and category average. “If similar funds are doing better, the underperformance could be due to the fund manager’s suboptimal decisions,” says Gurmeet Singh, head of wealth management, DiVitas Capital. Focus on consistency of performance. 

Identify reasons 

One, the fund’s asset under man­a­gement may have bloated, and the fund manager may be finding it hard to come up with a sufficient number of attractive investment opportunities.  Sec­ond, a new fund manager may have made significant changes to the portfolio. “If I am not convinced about the new fund manager’s capabilities, or there is a change in the fund’s fundamental attributes, I immediately take a deep dive into it,” says Melvyn Santarita, portfolio analyst at Geojit Financial Services. 

Third, the market may not be favouring the fund manager’s style. “Stay invested if the underperformance is tied to market cycles or short-term volatility, and the fund’s risk-adjusted returns remain reasonable compared to peers. The market may be favouring a different style. Growth funds may fall behind when value funds are outperforming,” he says. 

Fourth, a call may have gone wrong, affecting performance for months. Focus on whether the fund manager is taking steps to rectify it. 

Put fund on watchlist 

Give the fund manager adequate time to recover. “If underperformance persists for six consecutive quarters, which means the fund is in the bottom two quartiles, then it is a red flag. Put the fund on a watchlist because this is long enough for the fund ma­n­ager to do course correction,” says Mahesh Mirpuri, financial coa­ch and MF distributor. Put­ting a fund on watchlist does not necessarily mean you sell it, though you may stop your systematic investment plan (SIP) in it. If underperformance persists after eight quarters, exit. 

Handling mergers 

To cite an example, this year DSP World Agriculture Fund merged into DSP World Mining Fund. If you are not comfortable with a change of underlying fund in a fund of funds (FoFs), or the broadening, narrowing, or alteration of investment mandate due to a merger of schemes, decide whether you want to stick to the new entity. 

High returns in short period 

Those who invested during the market lows of March 2020 saw returns as high as 70 per cent within six months. If an investment has doubled within 12 months, it is unlikely to double again in the short term, but it could halve. Booking partial profits can be prudent. Consider personal factors. If you need money for an emergency, your goal is near, or with advancing age you prefer a lower allocation to equities, consider redeeming. 

    Don’t burn your fingers chasing hot funds 

• Past performance does not guarantee future results; market conditions that led to strong past returns may not persist

 

• Top-performing funds often revert to the mean over time

 

• Chasing performance can lead to buying high and selling low as investors pile into hot funds after they’ve already had strong runs

 

• Performance-chasing can result in frequent trading and higher costs

 

• Funds with the best recent performance often attract large inflows, making it harder to maintain that performance

 

• Focusing solely on returns ignores risk; high-performing funds may be taking on excessive risk