To avoid excessive investing losses, it’s usually best to buy a fund not just with a clear understanding of its strengths
, but also of the conditions under which it should be sold. Investors and clients usually focus on recurrent poor performance as a reason to sell, but in truth, there are other factors to consider.
According to Jeff McConnell, chief investment officer of Graystone Consulting, a change in portfolio management may be a cue to consider pulling out of a fund. “[W]hen the key investment decision-maker leaves and there is no strong backup, it may well be time to sell the fund,” he said in a think piece published by Morgan Stanley. Other changes, such as reorganization within the fund firm or the departure of multiple senior managers, should also encourage examination.
Next, performance should be assessed in relation to the broader market. When a large-cap growth fund does badly even though large companies are in favour, it’s a red flag. But if it underperforms during a pro-small-cap cycle, investors shouldn’t automatically count it out. “Actively-managed funds are often more concentrated in specific stocks or sectors than their benchmarks,” McConnell said. “That means you should expect some underperformance at times.”
Third, fund-asset fluctuations should be taken into account. Some strategies, such as buying micro-cap stocks, don’t work as well when the fund gets too large. At the same time, if a fund manager is financially unstable, drastic asset declines within a fund could force it to cut staff, which could hurt performance.
Fourth, growing competition could make it hard for a fund to outperform. The more rival funds pursue the same strategy, the harder it will be to accumulate assets from investors. There will also be a risk of steeper classes as multiple funds sell simultaneously when their favoured holdings go through hard times.
Fifth, check the fund’s cash position. If the manager appears to be holding too much cash, that may indicate challenges in finding attractive investments. “Investors may not want to shoulder the extra costs of an actively-managed portfolio if a big chunk of the fund’s assets are in cash,” McConnell said.
Finally, tax considerations should also be weighed. If there’s a capital-gains distribution expected from a fund, the client’s individual tax situation should be examined to determine whether it’s best to sell before or after the event.
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