How good is your exit strategy?

If you belong to the class of investors who exit mutual funds when markets fall and invest after they have risen, you are never likely to make money in the markets. Nowadays, with more and more investors investing in mutual funds via Systematic Investment Plans, the tendency to stop investing in equity mutual funds when the markets are down is on the decline. Nevertheless, having a sound set of criteria regarding when to sell your mutual fund holdings is perhaps as important as knowing which funds to invest in.


Investments in mutual funds should be made with a defined time horizon. Typically for long duration funds such as equity funds, the time horizon should not be less than three to five years. “Investors should invest with a goal — your child’s education, marriage, or retirement planning. Once the goal is attained, you may exit,” says R Raja, product head, UTI asset management company (AMC). However, under certain circumstances investors may have to take a call and exit a fund even before their goals have been attained.
Consistently poor performance. At the end of every year evaluate the performance of your fund. According to Vishal Dhawan, a Mumbai-based financial planner, “Compare the performance of the fund with its benchmark and category average returns. If the fund consistently underperforms against these benchmarks for a year, exit.” During the last one year prior to March, some funds did not do well when the markets were plunging. But the same funds did very well when the markets were on the upswing in the last couple of months. According to Gopal Agarwal, head-equity, Mirae Asset Global Investment (India), “Evaluate the performance of a fund and an AMC after at least a year, so that the cycle gets completed and you can get a clear picture.”



What investors also need to compare is the risk-adjusted returns of funds. Ratios such as Sharpe ratio and Treynor ratio allow you to do this. You may find this information on web sites such as valueresearchonline.com and mutualfundsindia.com and also in the fact sheets of funds.



To rebalance portfolio. Another reason for exiting or lowering your holding in a mutual fund could be that the markets have run up and your portfolio has become overweight in a certain asset class, such as equities. Says Dhawan: “Your asset allocation should depend on your risk appetite and investment horizon. Evaluate how much exposure you want to assets such as equities, debt, and commodities. If the asset mix gets skewed vis-à-vis a particular asset class in which you have invested through a mutual fund, you need to trim your exposure and get back to the original asset allocation.”
Change in fund mandate. Investment in mutual funds should be driven by objectives. If your objectives are not getting fulfilled, exit. Recently, a couple of mutual fund houses have proposed the merger of some of their schemes. When such an event occurs, you need to decide whether to remain invested or to exit from the merged scheme. “If there are changes in the mandate of the fund and if you find that your investment goals are not being met, opt for the exit,” says Dhawan. Adds Jaideep Lunial, a Chandigarh-based financial planner: “If the fund was invested 50 per cent in equities and after the change the exposure rises to 80 per cent, the investor should exit the fund if it does not suits his needs.”



Change of fund manager. Fund houses promote their star fund manager’s performance and launch new schemes under his name. Many investors too pursue the strategy of following the fund manager. They invest in mutual funds based on the fund manager’s reputation, and when the fund manager exits, they too exit along with him. An alternative approach could be to evaluate the qualities of the new fund manager by making inquiries about his track record. According to Lunial, follow-the-manager may no longer be a good strategy. “Of late, fund houses are no longer focusing on the fund manager. The performance of funds is becoming more system and process driven,” he says.



Burgeoning fund size. When the size of a fund becomes very large, producing market-beating returns becomes more difficult. If earlier, say, 30 investment ideas sufficed to fetch good results, now the fund manager needs a hundred or more. Or, for instance, a small-sized mid-cap fund may find it easy to pick up sufficient number of quality mid-cap stocks. But if the fund size balloons, finding so many quality mid-cap stocks might become difficult. If size is beginning to hinder performance, exit.

When you need money. This is one of the most important reasons for selling your mutual-fund holdings. However, before selling, decide which asset you should sell so that the returns from your portfolio get affected the least. “In a falling interest rate environment, where fixed deposits (FDs) lose their sheen and equities become attractive, selling the former could be a better exit option,” suggests Agarwal



Different categories, different motives



Investors invest in different categories of mutual funds for different reasons, hence their reasons for exiting these funds also vary. According to Krishnan Sitaraman, director, CRISIL Fund Services, “Typically, in case of liquid funds, investors, generally corporates, invest for a short time horizon and the decision to exit could be driven by their liquidity needs.” Moreover, Dhawan says, in a debt fund the quality of the portfolio, and not just returns, is critical. Investors invest in these funds as a substitute for deposits and don’t like to risk the principal. So they look not only at the risk associated with the portfolio, but also at the risk associated with the various components of the portfolio, he says.

Bottomline



According to Sitaraman, “Investments in mutual funds should be made for the long term unless one’s objective is to trade or to profit from short-term movements. You should ideally not exit investments in such categories prior to this time horizon unless there is an urgent requirement.”


Adds Lunial: “Bear in mind the exit load (if any) and the higher tax burden you may have to pay if you make an early exit.” For equity funds, the tax on short-term capital gains (if you sell within one year) is 16.99 per cent (inclusive of surcharge and education cess), while on long-term capital gains (if you sell after a year) it is zero. In the debt category, the short-term capital gains tax is charged at your marginal income tax rate. Long-term capital gains tax is the lower of the two rates: 10 per cent without indexation or 20 per cent with indexation. For an investor in the higher tax bracket, exiting after a year would be a less costly affair.

Investors who enter a mutual fund without a clear exit strategy are likely to meet the same fate as befell Abhimanyu who managed to enter the chakravyuh but then could not fight his way out of it.