Mutual Funds

A mutual fund is a company that combines, or pools, investors' money and, generally, purchases stocks or bonds. Ideally, a fund's size and resultant efficiency, combined with experienced management, provide advantages for investors that include diversification, expert stock and bond selection, low costs, and convenience.

In terms of legal structure, a mutual fund is a corporation that receives preferential tax treatment under the U.S. Internal Revenue Code. The assets of a mutual fund consist almost entirely of the securities it holds in its portfolio. The most common type of mutual fund, called an open-end fund, allows investors to buy and sell stock in it on an ongoing basis.

But, many investors are still to fully understand the concept of a mutual fund. They continue to treat it similar to investing in shares. Therefore, they tend to buy mutual funds for wrong reasons -- low NAV of a fund; dividend announced by a MF; New Fund Offer, etc.

The same misconception is seen in selling too. One of the most common instances of selling a mutual fund has been to invest in a New Fund Offer. This is under the false impression that a fund at Rs 10 is cheap and an excellent opportunity to invest.

Therefore, what could be the possible situations for selling a Mutual Fund?

Financing a need

A very obvious reason to sell would be when you need money. We all invest money with a view to finance some need or a desire in the future.

Say, you planned to buy a car or a house; or need to pay your child's fees; or maybe you want to take a vacation abroad. All this would require you to liquidate some of your investment.

However, proper choice is essential in deciding which fund(s) to sell. You could either sell those funds, whose performance has not been encouraging; or those where the tax impact is minimal; or those where the amounts are not very significant; etc. Or sometimes, possibly it may be better to borrow rather than sell a good investment.

Poor performance

There are more than 200 equity funds and their number is growing. The returns from practically all funds have been comparatively quite good, given the current bull-run. Even the worst performing funds have given 30-35% returns in last 1 year.

In absolute terms these are excellent returns. But when compared to the top performers with 110-115% returns, these look extremely poor.

However, the key here is to look at long-term returns - 1-yr, 3-yr & 5-yr - and compare it with both the benchmark index and other funds in the peer group. In the short term there could be a genuine reason for under-performance. Some of the investments may be from a long-term perspective; certain sectors may have been under-performers; contrarian investments take time to catch market fancy, etc.

If possible, one should also try and assess the reasons for poor performance. This will give a good insight into the market.

Rebalancing the portfolio

We all have a certain asset allocation across various investment options such as debt, equity, real-estate, gold etc.

A change in your financial position may require you to rebalance your portfolio. Suppose you are presently having a well-paid job and are unmarried with no liabilities. You can, therefore, take much higher exposure in equity MFs. But with marriage and kids your responsibilities may increase, which would require you to reduce you equity risk to more manageable levels.

Hence you would need to sell equity and re-invest in debt to restore the original balance.

Or maybe a new asset class has been introduced in the market - a real-estate fund or a gold fund - and you want to take advantage of it. Thus you may have to sell a part of your existing investment and re-invest in this new asset class.

Change in taxation policy

A change in the tax policy could become a reason to sell and reinvest somewhere else.

Change in Fund-Style or Objective

We invest in a fund with a particular objective or style in mind. Suppose, we already have exposure in mid-cap funds and in order to diversify our portfolio, we choose a large-cap fund.

However, after some time we observe that the fund is taking exposure in mid-cap sector too. This increases our overall exposure to mid-cap. Thus it may be time to sell and move to a truly large-cap fund.

Change in the Fund Manager

When investing, one of the criteria is to evaluate the expertise, knowledge, experience and past performance of the fund manager.

However, while the fund manager is a key player in managing our money, one should not forget the contribution of the research team, the investment committee, the top management and Asset Management Corporation's investment philosophy.

Therefore, a change the fund manager need not necessarily mean exiting the fund. But it may be worthwhile keeping the fund under a close watch. If there is a perceptible decline in the performance, one could consider selling.

Change in the Fund's Size

Sometime the size of the fund starts affecting the returns. This is because (i) the mid-cap space is limited (ii) even small purchase of such stocks sent their prices soaring and (iii) too large a holding in such stocks will be difficult to offload when required.

Here, of course the funds took a proactive step to protect the returns of the existing investors. But if the funds themselves do not take such a step, we investors should keep track of the fund sizes.