Worried about underperforming mutual funds? A negative return alone does not mean the fund is a bad investment. Equity markets go through ups and downs, and even a well-managed fund can deliver weak returns for a period.
The more important question is whether your fund is consistently lagging its benchmark and category peers over an appropriate investment horizon. A short-term fall may simply reflect market conditions. Persistent underperformance, however, deserves a closer look.
Before you sell, review the fund’s rolling returns, benchmark performance, category ranking, portfolio changes, and the fund manager’s track record. If the fund continues to lag its peers and benchmark for an extended period and the original investment rationale no longer holds, switching may be worth considering.
This article explains how to review your mutual fund portfolio in four steps.
1. Compare the Mutual Fund With Its Benchmark
The first step is to compare the fund’s performance with the mutual fund benchmarks it is designed to track or outperform. A mutual fund scheme delivering an 8% return may look disappointing on its own. But if the benchmark returned 6% during the same period, the fund has actually performed better than its benchmark index.
This is why looking at absolute returns alone can be misleading. For an actively managed fund, compare its returns with the stated benchmark across multiple periods. For an index fund, the focus should be on how closely it has tracked the benchmark after accounting for expenses and other tracking differences.
For example: Suppose an equity mutual fund has delivered the following returns:
| Period | Mutual Fund | Benchmark |
|---|---|---|
| 1 year | 9% | 11% |
| 3 years | 12% | 13% |
| 5 years | 13% | 12% |
The fund has lagged its benchmark over one and three years but outperformed it over five years. Looking only at the one-year return could therefore give an incomplete picture. You also need to pay attention to the benchmark.
It should be relevant to the fund’s investment strategy and the type of securities it invests in. The benchmark for a large-cap fund could be the Nifty 50 or Sensex, whereas a small-cap fund might compare its performance against the Nifty Smallcap 250, and so on for other funds.
What to review in your mutual fund portfolio
- 1-year performance
- 3-year performance
- 5-year performance
- Performance against the stated benchmark
- Tracking difference for passive funds
- Performance across different market cycles
One weak year does not necessarily indicate a structural problem. However, underperformance against the benchmark across several relevant periods deserves closer examination.
2. Compare It With Similar Funds in the Same Category
The next step in reviewing a mutual fund portfolio is to compare the fund with other schemes in the same category. A large-cap fund should generally be compared with other large-cap funds rather than a small-cap fund or other indexes. Similarly, a short-duration debt fund should not be judged against an equity fund.
This is known as a mutual fund category peer comparison.
Why peer comparison matters
Suppose your large-cap mutual fund generated a 7% return over three years.
At first glance, that may seem disappointing. But if most large-cap funds generated between 6% and 8% during the same period, the fund may simply be reflecting the broader market performance.
On the other hand, if comparable funds generated 10% to 12% while your fund delivered 7%, the difference deserves further investigation.
| Parameter | Fund A | Category Median | Interpretation |
|---|---|---|---|
| 1-year return | 8% | 10% | Lagging |
| 3-year return | 11% | 12% | Slightly Lagging |
| 5-year return | 14% | 13% | Ahead |
The objective is not to select the fund with the highest recent return.
Instead, look for consistency. You need to deeply investigate a fund that ranks near the bottom of its category over several periods, not the one that temporarily trails amid a difficult market phase.
Do not chase the highest-performing fund
However, you do not need to switch to the best-performing fund, as doing so could create another problem. This is because past winners can subsequently go through periods of weaker performance. Thus, you may end up repeatedly moving money from one recent winner to another.
Your review should therefore focus on consistency, portfolio strategy, risk and long-term performance.
3. Check Rolling Returns Instead of Only Point-to-Point Returns
Rolling returns can provide you with a more useful picture of consistency than a single point-to-point return. Rolling returns measure a fund’s return across multiple overlapping periods, such as every three-year period within a longer historical window.
For example, instead of looking only at the fund’s return from January 2021 to January 2024, rolling three-year returns can look at returns such as from:
- January 2018 to January 2021
- February 2018 to February 2021
- March 2018 to March 2021
- And so on
This gives you a much larger set of periods to assess the fund’s performance.
Why rolling returns in mutual funds matter
Suppose a mutual fund has delivered 12% over the last five years. That number alone does not tell you whether the fund consistently generated similar returns or whether one strong year lifted the overall figure.
Rolling returns can help answer questions such as:
- How consistently has the fund beaten its benchmark?
- How often has it outperformed category peers?
- How did it perform during different market cycles?
- How severe were periods of underperformance?
For long-term equity funds, three-year and five-year rolling returns can be particularly useful when evaluating consistency. However, historical rolling returns do not guarantee future performance.
4. Investigate Why the Fund Is Underperforming Before Switching
If a fund has consistently lagged its benchmark and category peers, the next step is to understand why. However, you don’t need to act during every period of underperformance.
A fund may temporarily lag because of its investment style. For example, a value-oriented fund may underperform during a period when expensive growth stocks lead the market. Its relative performance could improve when market leadership changes. Before deciding whether to switch, examine the following factors.
Portfolio strategy
Check whether the fund is still following the strategy you originally invested for. If you selected a fund for diversified large-cap exposure but its portfolio has changed materially, you may need to reassess the original investment thesis.
Portfolio concentration
Examine whether the fund has become significantly more concentrated in certain companies or sectors. A concentrated portfolio can lead to larger differences from the benchmark and category.
Fund manager change impact
The impact of a fund manager change should also be considered. A change in fund manager does not automatically mean the fund will perform better or worse. However, the new manager may have a different investment philosophy, portfolio construction approach or risk-management framework.
Review:
- Previous experience
- Investment philosophy
- Track record in similar mandates
- Portfolio changes after the transition
- Whether the fund’s stated strategy remains unchanged
Expense ratio
A higher expense ratio can reduce the returns investors ultimately receive. A persistent difference in costs can contribute to a wider tracking difference.
Risk and volatility
Returns should not be considered without risk. Two funds may generate similar returns, but one may have experienced significantly larger drawdowns. Therefore, you should examine volatility (standard deviation), downside risk (Sortino ratio), risk-adjusted return (Sharpe ratio) and other risk measures alongside returns.
When to switch Mutual Funds
There is no universal period after which you should automatically sell an underperforming mutual fund. The decision should depend on the fund category, investment strategy, market environment and the reason for the underperformance.
For an equity mutual fund, you generally need to give the strategy sufficient time to perform across different market conditions. However, if the fund underperforms over the long term, then you can consider exiting/switching out of the underperforming mutual funds.
When switching may deserve consideration
You may want to investigate a switch when:
- The fund consistently underperforms its benchmark.
- It persistently lags comparable category peers.
- The investment strategy has materially changed.
- The fund’s risk profile no longer matches your requirements.
- There has been a significant change in the fund management team accompanied by strategy changes.
- The fund no longer fits your financial goal or asset allocation.
- A passive fund consistently shows an unusually high tracking difference.
How Long to Wait Before Selling a Mutual Fund?
The answer depends on the type of fund and the investment objective. You need not evaluate a short-term debt fund and a small-cap equity fund using the same time frame. A more appropriate strategy is to review performance over several market cycles. If the fund underperforms over the long term, you may choose to sell it.
A practical review framework could look like this:
Stopping SIP vs mutual fund exit strategy
Stopping a SIP and a mutual fund exit strategy are two different decisions. Stopping a SIP means you stop making new investments while continuing to hold your existing units. Exiting a fund means redeeming some or all of your existing units.
Mutual Fund Exit Load and Tax
Before redeeming an underperforming mutual fund, you must check the mutual fund exit load and tax implications. A mutual fund levies an exit load when you redeem units within a very short specified period.
Tax is separate from the exit load. The capital gains tax applicable to a redemption depends on factors such as the type of mutual fund, holding period, and applicable tax rules. Long-term capital gains in excess of ₹1.25 lakh are taxed at 12.5%, while short-term gains are taxed at 20%.
Conclusion
An underperforming mutual fund does not necessarily mean it is a bad investment. Markets move through different cycles, and different investment styles can perform differently over time.
The better approach is to review the fund systematically. Compare its performance with the benchmark and category peers, examine rolling returns, and understand the reasons behind any persistent under performance. You can use tools like the MutualFundWala app to track and review your portfolio in one place.
If the fund’s strategy, risk profile, or long-term performance no longer fits your investment objective, you may consider exiting after evaluating the exit load, taxation, and replacement fund.
fAQs
How do I know if my mutual fund is underperforming?
You need to compare its performance with the appropriate benchmark and category peers across multiple periods. Also check rolling returns, risk and changes in the fund’s strategy.
How often should I review my mutual fund portfolio?
You should generally review your mutual fund portfolio annually, unless there is a major change in the fund, your financial goals or your personal circumstances.
What is rolling return in a mutual fund?
Rolling return in a mutual fund measures investment performance across multiple overlapping periods. It can provide a better picture of consistency than short-term performance.
When should I sell mutual funds?
You should consider selling a mutual fund when it has consistently underperformed its benchmark and category peers, or when its investment strategy, risk profile or other factors have changed. Short-term underperformance alone may not be sufficient reason to sell.
Does changing a fund manager mean I should sell?
Not on its own. You should evaluate the new manager’s experience, investment style, and the changes they have made to the fund’s portfolio and strategy.
