When people say "breaking up is hard to do," they're not talking about how difficult it is to say goodbye to a poorly performing investment. But knowing when to sell a fund that's gone astray is tricky, too. We're not talking about index funds; you either want exposure to a particular slice of the market or you don't, or you've found a cheaper option. But an actively managed fund poses a different set of questions. We've highlighted four traits that signal it may be time to sell. Any one of them might not be a sufficient cause to call it quits, but if a fund you hold has two or more of these qualities, you probably have reason to dump it.
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Returns are disappointing. Poor performance shouldn't be an automatic trigger to boot a fund from your portfolio. Consider first why the fund is lagging. Is the slump tied to the manager's bad investment choices? Or is the lull a periodic time-out because the fund's investment style is out of favor? For example, funds with a focus on discount-priced stocks have lagged in recent years compared with funds that invest in fast-growing firms. But that isn't always the case.
However, if a fund consistently struggles to keep up with its peers on a year-to-year basis, it's time to look for alternatives, says Todd Rosenbluth, head of exchange-traded funds and mutual fund research at CFRA. Keep the manager's tenure at the fund in mind. If he or she has been at the helm for only five years, it makes little sense to scrutinize the fund's 10-year record.
Give a manager some leeway; even the best ones stumble for a time. But if short-term sluggishness starts to drag down a fund's long-term returns, it's time to cut and run. That's a sign of sustained underperformance. Lew Altfest of Altfest Personal Wealth Management in New York, says he starts to get "very concerned" after a fund lags for two consecutive years. And if underperformance continues through a third year, "there's a good chance we'll be getting out," he says.
A manager leaves. When a key manager quits or retires, it's a "red flag," says Rosenbluth, because the new honcho may shift strategies or sell chunks of the portfolio. At the very least, be prepared for a period of growing pains when a new manager arrives. Challenges can come in the form of lackluster returns or big capital-gains distributions as the new manager reshapes the portfolio. In mid 2018, after Harbor International (symbol HIINX) lagged its benchmark five consecutive calendar years, a new manager took over. That December, shareholders received a whopping capital-gains distribution that was equivalent to roughly 38% of the fund's net asset value at the time.
Assets explode. The bigger a fund gets, the less nimble it can be and that can hurt returns. Small-company stock funds and concentrated funds, which tend to hold fewer than 30 stocks, can be particularly sensitive to asset bloat. The third-biggest small-company stock fund in the country, Vanguard Explorer (VEXPX), has $16 billion in assets. It has lagged its benchmark, the Russell 2500 Growth index of growing small-to-midsize companies, in seven of the past 10 calendar years, and it trailed the index over the first 11 months of 2019, too. But large-company funds have fallen victim to asset bloat, too. The legendary Fidelity Magellan (FMGAX) is a classic example. As assets topped $100 billion in 2000, the fund's performance relative to Standard & Poor's 500-stock index deteriorated.
The fund's job changes. David Mendels, an adviser with Creative Financial Concepts, says he views fund analysis as a job-performance evaluation. "I'm hiring a manager to do a job," he says--to invest in small-company stocks, say, or real estate investment trusts.
But funds can change over time. Fidelity Low-Priced Stock, once a U.S. stock fund, currently has more than a third of its assets invested in foreign stocks. It's a solid performer and may be worth keeping. But a big shift in holdings should be a wake-up call to rethink how a fund fits into your overall portfolio and whether you need to make any adjustments. "That's where I'd say, 'You're no longer doing what I hired you to do,' " says Mendels. "You're outta here."
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Copyright 2019 The Kiplinger Washington Editors