Are You Holding Non-Performing Mutual Fund Schemes In Your Mutual Fund Portfolio? - Outside View by PersonalFN

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Are You Holding Non-Performing Mutual Fund Schemes In Your Mutual Fund Portfolio?
Jun 10, 2019

Mutual fund is a simple way to invest in companies across different sectors with high growth potential and enables you to grow your wealth over time. As the funds invest in various companies, the performance of the scheme is linked to the overall performance of the companies it invests in.

The performance of the scheme also depends on how efficiently the fund manager selects the stocks depending on the objective of the scheme. While some managers may follow the value-style of investing, some follow growth-style. The assets they invest in differ from one scheme to another and may include equity, debt, and money market instruments along with its sub-categories.

This shows that every mutual fund scheme follows a different strategy and it will not be wise to treat it like any other investment avenue.

It is often observed that investors treat mutual funds like a bank fixed deposit. They think that once they have invested in the scheme, they need not worry about it and tend to forget about it.

This mistake comes to light when they have a look at their portfolio after many years, mostly when they want to redeem their scheme, and realise that they had been holding non-performing mutual funds all along.

[Read: Is Your Mutual Fund Portfolio On Track To Accomplish Your Financial Goals?]

A non-performing mutual fund is the one that has been consistently underperforming relative to its benchmark and peers. This means that your scheme was unable to give meaningful returns over a period of time.

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While no scheme, including a research-backed one, can outperform the benchmark every time; a consistent poor performance, say for more than one- or two-year period, is a sign of underlying issues with the quality of the fund management.

Under-performance over the short term can be due to volatility in the market or possibly because the fund manager took a contrarian bet than the market. It may take time for the fund to overcome the volatility and the fund manager's strategy may also take time to show results. So do not worry about a scheme if it is under-performing due to these reasons.

However, if the repeated under-performance is due to one of the following reasons, it is a sign of poor quality of fund management and you need to deal with it carefully.

  1. Lack of process-driven approach
  2. Lack of robust risk management system
  3. Poor skills and performance of the fund manager

[Read: Why Do Certain Mutual Fund Schemes Underperform?]

Another reason that can lead to the pile up of non-performing schemes in your portfolio is not following the right techniques to select the appropriate fund. Investors on many occasions select funds based on star ratings or on the recommendation of friends or relatives who may not be competent.

It is not wise to look at the star ratings of the scheme for the purpose of selection. Star ratings of the funds indicate how the funds performed in comparison to its benchmark and peers over the last few years. It does not reflect future growth potential of the scheme in any way.

Star ratings may take into account only quantitative aspects such as returns over the years, while qualitative aspects such as fund manager's skills and experience, investment systems and processes followed at the fund house may be ignored.

[Read: Why You Should Stop Looking At Mutual Fund Star Ratings Now]

This makes it necessary for investors to review their portfolio to find out such under-performing schemes. You can review your portfolio by checking the following points:

  • Comparing the performance of fund across different market phases using quantitative and qualitative factors
  • Concentration of investment to a particular fund house, a scheme category or sub-category
  • Alignment of the scheme's objective with your risk profile, investment objectives, financial goals along with time horizon

Reviewing your portfolio is crucial for your financial health because you can make sure it's on track to achieve your financial goals.

[Read: Why To Evaluate Mutual Fund Performance Across Bull And Bear Market Conditions]

To enable investors to achieve the objectives of their investment and not to be misled by the fund houses/managers, SEBI, in October 2017, came up with categorisation and rationalisation norms for mutual funds. It required fund houses to segregate their schemes into different categories as prescribed by the market regulator.

This was done to make it easier for investors to identify and select schemes best suited for their needs. It also ensured that the fund managers stuck to the objectives of the scheme and that they would not move to other categories in a bid to increase returns.

Fund houses were thus compelled to make changes in one or more of the following areas of the scheme- name change, change in fundamental attributes/ scheme type as well as merger of schemes. It is likely that your schemes underwent changes too and this makes it even more important to review your investments.

If the scheme has undergone only minor changes, you can compare the scheme using past performance. However, if the scheme underwent significant changes, such as changes in investment style or asset allocation, comparison using past performance may prove complicated.

In this situation, you must carefully go through the changes the scheme has made then determine if the characteristic of the scheme still aligns with your goals and risk profile. If you are comfortable with changes, you can continue with the investment and make sure to track the performance of the scheme post changes in the characteristics.

To reiterate, mutual funds must be carefully selected based on your needs by evaluating the schemes performance overtime based on quantitative and qualitative parameters. After selecting the schemes, make sure to review the portfolio at least once a year to track its performance. Do note that review should not be done too often as there can be lot of volatility in the short-term, which the fund may overcome once the conditions change.

If your scheme has undergone changes after SEBI's circular on categorisation, determine whether the changes will still allow you to fulfil your financial goals.

If you are holding non-performing mutual funds, a review will enable you to find out if there is a need to redeem the scheme and look for a better alternative. This will make sure that your goals are not compromised and that you are on the right track to achieve them.

You can consult an investment adviser who will be able to determine if you have selected the right schemes for your needs and suggest changes if necessary.

Editor's Note: If you do not want to hold non-performing funds in your portfolio so that it does not take a toll on your financial goals, I strongly recommend that you avail of PersonalFN's Mutual Fund Portfolio Review service.

Through this service, our investment adviser will give your portfolio the personalized attention it deserves by reviewing your existing mutual fund investments and then recommending the future course of action.

With our in-depth analysed recommendations, creating an optimal mutual fund portfolio will be a cakewalk.

Happy Investing!

Author: Divya Grover

This article first appeared on PersonalFN here.

PersonalFN is a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.


The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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