Heading for the Exits
The media has fixated on lackluster performances by once-superstar mutual fund managers, prompting many of these funds’ shareholders to pull the ripcord on their investments. But a short-term dip in performance isn’t always a reason to exit a fund.
Mutual funds that invest in US stocks have lost approximately $8 billion in net asset outflows so far this year, according to data recently released by the Investment Company Institute. Over the past decade, $51 billion has been withdrawn from domestic equity funds. These figures shouldn’t come as a surprise to market watchers. A wide swath of mutual funds performed poorly in 2008; two recession in the past decade meant hat many funds have nothing to show in the way of net gains.
But lagging performance is generally one of the worst reasons to sell out of a fund. That’s because chasing top-performers racks up significant fees, which erode a portfolio’s profits. Nevertheless, there are times when selling a laggard is justified.
Every fund manager, no matter how stellar the reputation, will eventually underperform the competition in a three- or six-month period. Consequently, the fund’s performance over a three- or five-year period is a better gauge of the manger’s stock-picking acumen. Funds that lag their peers over a one-year period should be red flagged and their performance monitored. If this performance is below par for a three-year period, it’s likely time to consider selling.
Management changes are another reason to consider selling a fund. We require all funds that are included in The Rukeyser 100 to have a manager with a three-year track record. Experience is critical in the money management business, especially if a fund employs a non-traditional strategy. Investors are in the markets to make money, not to subsidize a new manager’s education.
There are exceptions to the rule, whoever. A lack of experience isn’t a deal breaker when it comes to purely passive index funds. In this case, fund managers don’t make subjective decisions about when to buy or sell a stock. They merely execute trades dictated by the composition of the fund’s underlying index.
Investors should also consider selling a fund if its strategy changes. Each fund serves a specific role in a portfolio based upon its strategy. But a fund may change its strategy if it grows its assets substantially or has difficulty executing on its investment objectives. For example, a small-cap fund may grow its assets under management to the point that it becomes difficult to move in and out of small-cap names. In this case, mid-cap names may begin to feature prominently in the fund’s portfolio. This shift can change the complexion of your portfolio in unintended ways.
Occasionally funds change their names or notify investors of a change in strategy. But more often than not, a strategy shift results from subtle changes that occur over time. Be sure to check up on your funds every quarter.
Minimizing expenses is one of the keys to successful mutual fund investing. Expenses come out of your pocket, and rising fees are one of the best reasons to sell a mutual fund. It’s fairly rare for a fund to boost its expenses, but it can happen if management wants a raise or if the fund isn’t growing assets as well as expected. When a fund raises its fees, you should compare the fund’s expenses to those of competing funds. If the new costs are in line with the competition, it doesn’t make sense to abandon ship. But it might be wise to switch to a cheaper fund, so long as your holdings aren’t subject to early withdrawal or redemption fees.
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