One of the often repeated statements I hear is about Distributors advising clients to stick to the funds even though the fund may have under-performed for 2 – 3 or even 5 years (rare but have heard that number). The essence though is that if you stick long enough, who knows, even the tortoise may cross the finishing line (remember, goal has shifted from winning to completing).
I would actually have agreed with the waiting period if some one came up with evidence on why it makes sense to wait for X years in a fund that is under-performing but before we go further, lets first try and understand how performance is measured.
Basically there are two ways to measure performance
- Relative Performance: Here, you compare the performance of a fund with its peers. For instance, if you are a investor in say HDFC Top 200, you will likely compare the fund against funds such as Franklin India Bluechip Fund / Birla Sun Life Frontline Equity Fund
- Comparing against the Benchmark Index
In Relative Performance, the key is whether the fund one is invested in remains in the top quartile for the maximum period of time. This check ensures that you are with a fund whose fund manager has showcased the ability to deliver the goods.
The second way of measuring performance is by comparing its returns against the Benchmark Index. Any additional returns generated here without adding for Risk is known as Alpha though you will need to make certain that the performance has been delivered without actually investing big time in stocks which are in no way associated with the Benchmark under consideration.
The reason I say this is because, fund managers (especially of Sector funds) have shown how they achieved out-performance by investing in sectors which are no way connected with the core sector the fund is named after.
While you may argue, any out performance is good, the point that gets missed is that the performance may be more due to Luck and less the skill of the fund manager. But I am digressing
Lets start with what happens when funds start under performing for long (3 years by my score is a long time indeed). If you have a housing loan, you will know that all other factors being the same, a small hike in interest rate can extend the term of your loan by years.
When funds you have invested under perform, they impact in terms of how fast you can achieve your financial goals. Remember, the whole concept of Retiring at X years or ability to fund children’s education is based on the assumption that investment in MF’s (which can be a big part of one’s portfolio) yield a certain return. Take out a percentage or two and you will find yourself either having to commit more per month or worse finding it too late that more sacrifices would be necessary to achieve the goals outlined years earlier.
And as much as its true that on the long term, you can get better returns by just sipping regardless of what is happening in the real world, do note that blind investing can only return you average returns (and many a time even worse) which you could have well achieved without having to take the risks that come with the market.
And finally, the fund manager is paid big bucks to get you the extra returns since you can always perform in line with the Indices by buying a cheap ETF (Nifty Bees on Nifty 50 for example).
