My Mutual Fund Underperformed in 2011; Should I Sell?

Factors to consider when deciding whether to dump a fund

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Roger Wohlner

As a member of NAPFA (the largest professional organization of fee-only financial advisers in the country), I receive a fair number of press requests during the week. One that came in today was from a reporter asking advisers if we were selling a well-known actively managed fund based on its recent underperformance.

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A large percentage of my client holdings for both individual and institutional clients are invested in index products (both mutual funds and ETFs). These vehicles are low cost and style specific, and the latter quality helps in the asset allocation process. Additionally, many index funds have outperformed the majority of active managers in their peer groups.

Active funds are a bit of a challenge. At a continuing education seminar a few years ago, the instructor mentioned that it would not be uncommon for a fund that is ranked in the top 25 percent of its peers over a ten-year period to have experienced two or three calendar years in the bottom 25 percent during that time span. I have seen these types of performance swings often over the course of my career.

The question raised by this reporter is an interesting one, especially in this world of rapid trading and instantaneous information.

In an e-mail response to the reporter, I mentioned that the fund in question had not placed in the bottom half of its peer group of funds during any calendar year from 2001-2010; 2011 was the first such year. Further, the fund’s trailing five-, ten-, and fifteen-year relative returns were stellar.

In evaluating whether to sell an active mutual after a period of poor performance or at any time, here are some factors to consider:

  • Has the investment philosophy of the fund changed?
  • Has there been management turnover? For example, have the folks who compiled the fund’s prior track record left?
  • Has there been a significant increase or decrease in the fund’s assets under management?  An increase might hinder the manager’s ability to find and implement solid investment ideas going forward. This can be especially true of funds in the small- and mid-cap areas. In the case of a significant decline in the level of assets, this could lead to a fund closure or a consolidation of the fund with another fund in the same family.
  • At the end of the day, an investment in an actively managed mutual fund requires evaluation at the front end and ongoing monitoring of the fund against its peers and your expectations.

    Roger Wohlner, CFP®, is a fee-only financial adviser at Asset Strategy Consultants based in Arlington Heights, Ill., where he provides advice to individual clients, retirement plan sponsors, foundations, and endowments. He recently cofounded Retirement Fiduciary Advisors to provide direct investment and retirement planning advice to 401(k) plan participants. Follow Roger on Twitter and LinkedIn. Roger also blogs at Chicago Financial Planner.