{"id":309,"date":"2019-05-15T12:26:08","date_gmt":"2019-05-15T12:26:08","guid":{"rendered":"http:\/\/blog.certifiedfinancialguardian.com\/?p=309"},"modified":"2019-05-15T12:49:43","modified_gmt":"2019-05-15T12:49:43","slug":"why-do-certain-mutual-fund-schemes-underperform","status":"publish","type":"post","link":"https:\/\/blog.certifiedfinancialguardian.com\/index.php\/2019\/05\/15\/why-do-certain-mutual-fund-schemes-underperform\/","title":{"rendered":"Why Do Certain Mutual Fund Schemes Underperform?"},"content":{"rendered":"\n

Responsible investment advisers always recommend mutual funds<\/a> with a proven track record to investors\/clients. And they hope that their suggested schemes will continue to outperform not only the benchmark indices but even the peers in the fund category. <\/p>\n\n\n\n

Investors too expect to maximise their returns in their journey of wealth creation<\/a> when they invest in top-rated schemes.<\/p>\n\n\n\n

Despite the diligence of investment advisers and investors, many\nmutual fund schemes underperform.<\/p>\n\n\n\n

What leads to the underperformance of mutual fund schemes?<\/p>\n\n\n\n

Let\u2019s find out\u2026<\/p>\n\n\n\n

But before that please remember: no mutual fund scheme can\nremain a top-performer every year through all market phases. <\/p>\n\n\n\n

In fact, underperformance shouldn\u2019t be always seen with\npessimism, particularly if the mutual scheme follows a well-thought investment strategy\nand comes from a fund house that follows robust investment processes and\nsystems. <\/p>\n\n\n\n

For instance, when a handful of stocks drive the market\u2013\u2013like some have\nover the past 12-15 months\u2013\u2013\u2013a well-diversified fund will underperform. <\/p>\n\n\n\n

Contrary to what you might think, isn\u2019t it sensible to stay\nput if the fund\u2019s portfolio is well-constructed and diversified that can\npotentially make up for the underperformance in the long run? And as you may\nknow, holding an ultra-concentrated portfolio of certain heavyweights that\ndrive the benchmark index is far riskier (exposes you to extreme volatility)\nthan holding a well-diversified portfolio.<\/p>\n\n\n\n

[Read:<\/strong> Is Your Mutual Fund Portfolio Overcrowded?<\/a>]<\/p>\n\n\n\n

Shifting from an underperforming mutual scheme to a\nperforming one is a crucial choice; hence, you should make it carefully. <\/p>\n\n\n\n

Take another example, if all schemes of the same mutual fund\nhouse have underperformed, it could be well because of some strategy or\ninvestment process and systems going wrong at the fund house level. <\/p>\n\n\n\n

For instance, had the fund house or a scheme been an underweight\non the NBFC sector in 2017, it would have resulted in considerable\nunderperformance. But this strategy has proved to be\neffective in 2018 and 2019, so far.<\/p>\n\n\n\n

You see, it is the  repeated\nunderperformance that calls for attention to the quality of fund management. You\nneed to deal with it carefully. <\/p>\n\n\n\n

What\u2019s common among habitual\nunderperformers?<\/strong><\/p>\n\n\n\n

Lack of process-driven approach \u2013 <\/strong>Mutual fund houses that rely excessively on their\nfund managers, usually end-up underperforming, when their star fund managers\nleave the fund house. <\/p>\n\n\n\n

Lack of robust risk management\nsystems<\/strong> \u2013<\/strong> When a fund manager takes excessive\nrisk, chases momentum, ignores the fundamentals and portfolio diversification;\nmutual fund schemes under his\/her watch underperform. <\/p>\n\n\n\n

Experience of the fund management\nteam \u2013 <\/strong>During the bull\nmarket phases, even inexperienced fund managers and their teams survive. But the\nreal test is when the market hits a turbulent patch for a fairly long time\nperiod (months to years) and\/or enters a bear phase. That separates the wheat\nfrom the chaff and give an indication of their skillset, conviction, grit, and\ntemperament. <\/p>\n\n\n\n

If the fund manager and his\/her team are inexperienced, he\/she\ncould fail to recognise the change in market cycles or the undercurrents,\nalthough no single portfolio strategy can work under all market conditions. <\/p>\n\n\n\n

For instance, staying invested in infrastructure stocks post-financial\ncrisis could have cost a pretty penny. Even though the infrastructure theme had\ncreated massive wealth between 2001 and early 2008, since then, the capital\nappreciation in this theme has been limited. <\/p>\n\n\n\n

Similarly, if you go back to the dot com era, mutual fund\nmanagers were bullish on technology stocks, but many of these today are much\nlower than their all-time highs. <\/p>\n\n\n\n

Take one more example, the pharmaceutical sector did\nexceedingly well post the financial crisis; however, if a mutual fund had remained\noverweight on that even after 2013, it may have shown on the underperformance\nof a mutual fund scheme. <\/p>\n\n\n\n

fund managers who could foresee the infrastructure boom\nstayed away from them. Their patience bore fruits for next 6-8 years. <\/p>\n\n\n\n

The change could come in any form, structural or cyclical. Opening of the Indian economy in 1991 was a structural change. Implementation of GST<\/a> is a structural change. Demonetisation<\/a> was a structural change, to an extent. Such changes can throw up opportunities and threats; new winners and losers. <\/p>\n\n\n\n

Therefore, the experience of the fund management team holds\nthe key.  <\/p>\n\n\n\n

Appetite to outperform \u2013 <\/strong>Fund managers are always keen to show\noutperformance in schemes under their watch. Sometimes, this tendency makes\nthem myopic. They tend to focus too much on the short term (chase momentum) and miss\nthe bigger picture (the fundamentals). <\/p>\n\n\n\n

What should IFAs do when their\nrecommended schemes underperform?<\/strong><\/p>\n\n\n\n

IFAs should avoid churning portfolios (recommend switches to\nanother scheme) of investors looking at merely the short-term underperformance\n\u2013 the returns. <\/p>\n\n\n\n

Instead, digging deep to recognising the portfolio\ncharacteristics of the mutual scheme, the securities bought and sold by the\nfund manager, the macroeconomic undercurrents, and if the investment strategy\nwas truly followed as per the scheme\u2019s mandate can help take a prudent call and know the reasons\nfor underperformance. Beyond this, as mentioned earlier, paying attention to\nthe investment process and systems of the fund house is necessary. <\/p>\n\n\n\n

Once the above is done, if the scheme has been consistently underperforming\nshould raise a red flag. If a scheme underperforms despite taking all due care\nat the time of selection, IFA shall search for suitable substitutes.<\/p>\n\n\n\n

IFAs need to keep track and recommend substitutes (mutual fund schemes) that are in line with the investment objectives, risk profile, financial goals<\/a>, and the investment time horizons of the investor. <\/p>\n\n\n\n

A word of advice for investors\u2026 <\/strong><\/p>\n\n\n\n

Instead of switching from an underperforming fund to a star-rated fund<\/a>, investors must try to identify reasons behind the underperformance by doing their own research and then, of course, reach out to their investment adviser for more meaningful advice, so that investors can be handheld in the path to wealth creation. <\/p>\n\n\n\n

[Read:<\/strong> Why You Should Stop Looking At Mutual Fund Star Ratings Now<\/a>] <\/p>\n\n\n\n

The other occasions when investors\nshall redeem their mutual funds are:<\/strong><\/p>\n\n\n\n