Sep 01, 2023 / Reading Time: Approx. 10 mins
In recent months, the equity markets have experienced a significant upswing, propelling the S&P BSE Sensex to reach new heights, crossing the impressive 65,000 milestone just last month. The market continues to trade around this remarkable level.
In times like these, investors often contemplate capitalising on their gains by selling portions of their holdings in stocks and equity mutual funds. While the allure of reaping profits during market highs is undeniable, the challenge arises in determining the optimal timing and conditions for selling mutual funds. Deciding whether and when to sell requires a careful evaluation of multiple factors.
So, are there established guidelines or a structured strategy to assist in making well-informed selling decisions? Allow me to provide some insight.
In this article, we will delve into a dilemma frequently encountered by mutual fund investors: whether to sell mutual funds at market highs. If the answer is affirmative, what parameters should be examined before executing such sales? Making the right selling decisions necessitates compelling reasons, as overlooking the potential future gains of your existing fund holdings can lead to regret.
Let’s explore the criteria for evaluating selling decisions and shed light on strategies for distinguishing between funds to retain and those to sell within your portfolio. This exploration will empower you to make prudent choices on which funds to retain and which to divest, maintaining a well-balanced portfolio. To begin, let’s address the fundamental question:
When is it appropriate to consider selling your mutual funds?
Mutual funds offer an excellent investment avenue and can serve as valuable long-term assets. However, there are scenarios when reassessing and potentially selling a portion of your investment holdings becomes prudent.
Selling mutual fund investments during market highs can be a strategic move for several reasons. Firstly, it allows you to harness the growth of the market and lock in profits before potential declines. Capitalising on market highs enables you to secure the gains accumulated over time, thus protecting against loss or diminishing returns during market downturns. Additionally, selling during market peaks facilitates portfolio rebalancing by reallocating funds to undervalued assets. This practice ensures your portfolio remains balanced and aligned with evolving market dynamics.
Nevertheless, the decision to sell, especially during market highs, demands thorough analysis. It should factor in your financial goals, risk tolerance, and market outlook. Sound judgement is imperative to capitalise on market highs without exposing yourself to unnecessary risk.
When contemplating profit booking or selling mutual funds, a comprehensive evaluation of each holding is vital. This approach ensures your selling decisions are well-informed.
Let’s examine some compelling reasons or criteria that can guide you in determining the benefits of selling your mutual funds.
Reason #1: Constant Underperformance
Imagine a cricket team with a player symbolising a mutual fund. This player consistently trails in performance compared to their teammates. Initially, you attribute it to a temporary setback, hoping for improvement. However, persistent underperformance adversely affects the team’s overall success.
|Fund Name||1 Year||2 Year||3 Year||5 Year||7 Year|
Similarly, consistently underperforming mutual funds lagging behind benchmarks or similar funds in their category demand attention. When a fund continuously underperforms its benchmark and category peers, it serves as a cautionary signal. However, if the underperformance is only short-term, it could be reasonable to wait and see if there is a bounce-back or improvement in performance. Nonetheless, a mutual fund’s performance should be evaluated over a reasonable time frame, typically three to five years. If a fund consistently fails to generate satisfactory returns, reallocating to alternatives with stronger track records could be prudent. Replacing an underperforming mutual fund with better alternatives could safeguard your investment strategy.
Reason #2: Variation in the Fund’s Objective Or Strategy
Consider an architect designing a building. Each component, akin to a mutual fund, contributes to the strength of the structures. If any part deviates from the concrete plan, it would impact the stability of the structure.
Similarly, mutual funds with changing objectives could disrupt your financial blueprint. Mutual funds are designed to meet specific investment objectives and accordingly have a stated investment objective that defines the fund’s focus and strategy. If the fund undergoes a significant and unexpected change in its objective that no longer aligns with your investment goals or risk tolerance, it may be wise to sell.
For instance, if your fund starts investing differently by venturing into risky areas that are outside of your risk tolerance, or if you see a shift in your fund’s investment strategy, say from a conservative approach to a more aggressive strategy; and if such shift doesn’t align with your investment preferences, it could undermine your financial plan. Selling such funds and exploring better options could safeguard your core portfolio strategy.
Reason #3: Change in Fund Management And Philosophy
Mutual funds are like cricket teams with coaches. Just as a coach guides strategy, fund managers drive investment decisions. They play a crucial role in the performance and decision-making process of a mutual fund. If a coach changes, the team’s overall performance may be affected. Similarly, if a mutual fund sees a change in the fund manager, the investment strategy might change.
As the fund managers and management team dictate investment approaches in mutual funds, leadership changes or shifts in the investment philosophy can easily jeopardise its performance.
|Baroda Mutual Fund||Baroda BNP Paribas Mutual Fund|
|BNP Paribas Mutual Fund|
|BOI AXA Mutual Fund||Bank Of India Mutual Fund|
|DHFL Pramerica Mutual Fund||PGIM India Mutual Fund|
|IDFC Mutual Fund||Bandhan Mutual Fund|
|Indiabulls Mutual Fund||Groww Mutual Fund|
|L&T Mutual Fund||HSBC Mutual Fund|
|Principal Mutual Fund||Sundaram Mutual Fund|
|Reliance Mutual Fund||Nippon India Mutual Fund|
|Union KBC Mutual Fund||Union Mutual Fund|
|YES Mutual Fund||WhiteOak Capital Mutual Fund|
Sometimes, a mutual fund undergoes a change in its sponsors or management company, resulting in a new team overseeing the fund’s operations. This change may bring uncertainty and a potential shift in investment approach. A new fund manager or a change in the management team may lead to a different investment strategy, impacting the fund’s performance and showing a deviation from the fund’s historical success.
If you’re uncomfortable with the new fund manager or the management team or even the changes in philosophy being implemented, selling and reassessing alternatives may be prudent.
Reason #4: Portfolio Overlap
Imagine a coach selecting players for a football team. Each player, like a mutual fund, possesses unique skills. If two players have similar skills, it could help one approach but might not have the required flexibility.
|Fund A||Fund B||Fund C|
|Company Name||Holding %||Holding %||Holding %|
|ICICI Bank Ltd.||9.58||9.82||10.50|
|Reliance Industries Ltd.||5.98||7.67||7.08|
|Larsen & Toubro Ltd.||4.04||7.43||8.11|
|HDFC Bank Ltd.||12.01||6.18||5.59|
|Axis Bank Ltd.||3.50||4.80||4.21|
|Ultratech Cement Ltd.||1.05||3.95||4.63|
|Bharti Airtel Ltd.||3.30||3.51||2.92|
|Maruti Suzuki India Ltd.||1.69||3.38||4.06|
|Hero MotoCorp Ltd.||1.17||1.65||3.01|
|Sun Pharmaceutical Industries Ltd.||2.85||1.42||2.78|
|State Bank Of India||3.55||0.83||—|
|SBI Life Insurance Company Ltd.||—||1.41||2.77|
|Coal India Ltd.||2.45||0.71||—|
|Oil & Natural Gas Corporation Ltd.||0.72||—||1.38|
|Bharat Petroleum Corporation Ltd.||—||0.29||1.13|
Similarly, mutual funds with overlapping holdings reduce diversification potential. Overlapping assets could lead to the potential problem of overexposure and concentration risk, thus amplifying the risk exposure in your portfolio.
In simpler terms, if a large part of your investments is connected to the same assets or types of assets, effectively, any downward shifts in the value of those assets can magnify the impact of any negative fluctuations in their values and have a bigger negative effect on your overall portfolio.
Hence, regularly assessing your portfolio’s diversification is critical. If your mutual funds have overlapping holdings with other schemes, it would intensify the concentration risk in your portfolio. Selling redundant holdings and reallocating to diverse assets could help you mitigate this risk.
Reason #5: Deteriorating Fundamentals & Higher Cost
Imagine being a mutual fund investor; you noticed something odd about a mutual fund scheme you own, which could be a troubling sign. Its assets are dropping, redemptions have increased as more people are pulling out their money, and the fund’s overall health appears weak. You are bound to get a bit anxious. A deeper investigation reveals the fund’s declining popularity.
If a mutual fund experiences consistently higher redemption rates, causing a substantial decline in the AUM, it may be an indication of underlying issues. High redemption pressure could strain the fund’s performance and even lead to liquidity concerns.
Timely selling such funds could safeguard your capital from potential losses linked to declining fund popularity. Moreover, transparency is crucial. Selling funds lacking transparency and moving to more clear alternatives enhances your understanding of the fund. Additionally, high expense ratios can erode your returns over time. Selling funds with high expenses and shifting to cost-efficient alternatives could optimise your overall gains.
Key Steps for Informed Selling Decisions
Selling mutual funds should be a well-considered process aligned with your investment strategy. To make this process systematic and effective, you could follow these steps:
1. Align with Your Investment Goals: Selling a mutual fund should align with your long-term investment objectives. Ensure that your selling decision fits into your overall investment strategy. If you are unsure, then consulting a financial advisor for personalised guidance could be beneficial.
2. Analyse Your Investment Portfolio: Evaluate your entire portfolio to ensure your selling decisions harmonise with your broader asset allocation and financial goals. Ideally, you should aim to diversify your portfolio with investments that could offer better growth potential.
3. Research Alternative Options: Prior to making the decision to sell your current fund, thoroughly research alternative options that match your investment goals, objectives, and risk tolerance. Carefully examine and shortlist potential alternative investment options that align with your investment objectives and risk profile.
4. Tax Implications: Selling a mutual fund may result in tax consequences, i.e. capital gains or losses. Understand the tax consequences and consult a tax advisor to optimise your tax strategy.
5. Monitor Market Conditions: You should keep an eye on the prevailing market conditions and trends that might influence your decision to sell. Stay informed about the market trends that could be crucial in your strategy and help you maximise your returns.
6. Evaluate Costs: Prudently assess the associated fees and charges associated with selling your mutual fund as they would impact the net gains on your investments.
Selling mutual funds requires meticulous thought and strategic alignment with your investment approach. As with any investment decision, it’s crucial to take a thoughtful approach, regularly review your portfolio, conduct thorough research, seek advice from financial professionals, and make informed choices based on your individual circumstances that could support your financial goals.
While the complexity of selling decisions is undeniable, leveraging this process can optimise your portfolio, ensuring that your investments align seamlessly with your evolving financial objectives.
VIVEK CHAURASIA is the editor of FundSelect and FundSelect Plus, the flagship research services of PersonalFN.
Having over a decade of experience in analysing mutual funds, Vivek understands the functioning of the mutual fund industry very well and applies his financial and analytical skills to closely scrutinize each fund to his satisfaction.
Vivek joined PersonalFN as a Senior Research Analyst in 2009 and quickly adopted the philosophy of our research team, i.e. honest and unbiased research for naive investors who are tired of being mis-sold. Over these years, he has developed a robust fund selection and filtration model – ‘SMART Score matrix’ that has been tested across various cycles now and constantly looks for a scope to strengthen it further. Vivek follows the principle of safety first when it comes to picking funds for investors. That is the reason why he has a long list of rejected funds as compared to the ones he has endorsed so far.
Vivek is an avid follower of John C. Bogle (the founder of The Vanguard Group and the author of the bestseller book – Common Sense on Mutual Funds: New Imperatives for the Intelligent Investor) and Warren Buffet (one of the most successful investors of all time)
Disclaimer: Investment in securities market are subject to market risks, read all the related documents carefully before investing.
This article is for information purposes only and is not meant to influence your investment decisions. It should not be treated as a mutual fund recommendation or advice to make an investment decision in the above-mentioned schemes.