Knowing when to sell a fund is arguably as important as knowing when to buy one. But there is much less guidance on this topic for private investors. “Recommendations on which investment funds to buy are often provided by investment companies and product providers that are keen for you to invest with them, so they can look after your money and, of course, charge you for the privilege,” says Patrick Connolly, chartered financial planner at Chase de Vere. “But while these companies are happy to recommend funds to buy, it is more unusual for them to suggest funds which you should be selling.”
There are a number of issues to consider when deciding whether to sell a fund.
Many investors sell a fund if they think it is underperforming. Gavin Haynes, managing director at Whitechurch Securities, says he sold Standard Life Global Absolute Return Strategies (GB00B7K3T226) two years ago because the fund was not living up to his expectations of its risk/reward balance.
And when managing client portfolios Colin Low, managing director of Kingsfleet Wealth, sells a fund if it has underperformed its sector average for more than two quarters in a row. “I know that’s quite harsh, but we don’t want to hold a fund that’s underperforming its peers unless there’s a very good reason,” he says. “People often form an emotional attachment to funds, so having a strong sell discipline and method of selling them is useful.”
But if you are going to sell a fund based on performance make sure you compare like with like by evaluating funds against other funds that use a similar investment style. For example, in recent years, growth-style funds have performed better than value funds. So to get a more accurate picture of a fund’s relative performance you should compare value-style funds against other value funds and growth funds with other growth funds.
Also, because of the impact of style you shouldn’t rely solely on performance figures to evaluate a fund. And you need to make sure you understand the fund’s objective, process and asset allocation as these have an impact on its performance.
“You need to understand why a fund has underperformed and if this is likely to change in the future,” says Mr Connolly. “For example, passive funds perform comparatively well when large companies do well. This is because they tend to have a high weighting in larger companies, reflecting the wider stock market. But when mid- and small-cap stocks perform well passive funds can be left behind. Similarly, ethical funds avoid some sectors such as tobacco, and typically have lower weightings in areas like oil and gas. Because of this their comparative performance is often dictated by how the sectors they hold perform compared with those they don’t hold.”
And David Coombs, head of multi-asset investments at Rathbones, says: “Very rarely should you sell on the basis of performance. The problem with selling a fund if it has underperformed for two quarters is that markets are often irrational in the short term. People selling funds after they have fallen could mean they are selling at the bottom. Most people wouldn’t do that after a stock has fallen, but people seem to act in a different way when trading funds. Many investors sell a fund after it has fallen even though its underlying stocks are cheaper.”
A fundamental change
A significant change in the way a fund is run should be a signal to reassess your decision to own it. Examples of this include a change in a fund's manager or the investment process it uses.
“The key for me when deciding whether to sell a fund is not underperformance, as that could be style driven, but the fund manager’s understanding of that underperformance and whether they stick to their process or not,” says Adrian Lowcock, head of personal investing at Willis Owen. “If a manager used to buy and hold a concentrated portfolio of stocks, and now they are buying and selling a lot more stocks, this behaviour change shows they have abandoned their process or lost confidence in it. Either way, it’s not good.”
He would rather hold a fund that is performing poorly but meeting its objective in terms of sticking to its investment style. For instance, he rates M&G Recovery Fund (GB00B4X1L373) run by Tom Dobell, which takes a contrarian approach by investing in companies that are out of favour with the market. The fund’s performance has suffered over the past five years as the market has rewarded high-growth companies rather than recovery situations.
“Investors can make a call on style and sell a fund if they believe its investment style is going to remain out of favour, but the challenge you have is knowing when to get back into that style,” warns Mr Lowcock. “No one style is suitable for all market environments. That’s why overall I prefer having [funds with] a mix of styles, so some are always doing well even if others are underperforming.”
While there is an argument for selling a fund if its manager leaves or its investment management team changes substantially, investors shouldn’t necessarily rush and sell the fund immediately. Usually after the announcement that this is happening the manager will serve out a lengthy notice period. And when a new manager takes over they may not change the investment process substantially. Even if a new manager does plan extensive changes, it will take time to sell out of the fund’s holdings, which means the portfolio will remain similar for a while.
“[When deciding whether to sell due to a management change] you should understand the role and importance of the fund manager,” says Mr Connolly. “Some managers, such as those at Jupiter, Artemis and Fundsmith, play a dominant role in the investment process and if they leave this can cause a major upheaval. But other investment companies, such as Newton and Columbia Threadneedle, have more of a team-based approach so it might still be business as usual when a fund manager leaves.”
Fund size
The most important sell signal for Mr Coombs is if a fund has grown to a size that is not compatible with its investment strategy, or its manager’s strength and skillsets. "These can be outweighed by the amount of money that the manager is running,” he explains. “For example, if a fund gets too big when investing in assets which are relatively illiquid, the bigger the fund becomes, the more the nimbleness of the trading will be compromised. That is massively overlooked in terms of UK equities, where the market is much thinner in terms of liquidity than the US. In the UK, size really does matter.”
So he believes that UK equity focused funds with more than £3bn of assets under management are generally more likely to struggle, so investors should look to sell them.
However, funds investing in US large-cap equities and US mid-cap equities could afford to grow to a much larger size because of the greater liquidity of their underlying holdings. Likewise, a fund investing in highly liquid global government bonds would be able to maintain its investment strategy even with several billion pounds’ worth of assets. But a bond fund specialising in niche, less liquid asset classes would need to be smaller to maintain the ability to quickly trade in and out of holdings.
A manager whose fund has massively increased its assets under management, meanwhile, may become overconfident which could lead to performance suffering. So it could be worth reassessing your case for holding such as fund.
“The industry is so focused on star mangers that often they end up running far too much money,” says Mr Coombs. “Investors might feel it’s much safer to invest with these managers as they recognise them almost as brands. But fund managers are people and susceptible to the same characteristics as anyone else. When a manager becomes very successful, a bit like some chief executives, they become too powerful in their organisations and can become complacent, arrogant or less willing to be challenged.”
Portfolio management
You might also decide to sell a fund because of changes you want to make to your portfolio.
“Perhaps the most common reason for us to sell a fund is if our top-down view of the world has changed, and this leads to a change in asset allocation because we believe there may be better opportunities elsewhere," says Mr Haynes. "Valuation is another key reason: if we believe an asset or market is looking expensive then we would sell a fund with exposure to that particular area.”
Many investment analysts think it is a good idea to reassess your asset allocation by reviewing your portfolio at least once a year. At the same time as you do this, Mr Connolly suggests rebalancing your portfolio by decreasing your holdings in funds that have performed well.
“To ensure that you don’t end up taking too much or too little risk, you should rebalance regularly,” he says. “This involves selling some of your investments that have performed well and now represent a larger proportion of your portfolio, and reinvesting in those that have performed badly so now account for a smaller proportion of your portfolio. This will help to get you back to your starting position. Not only does rebalancing ensure that you don’t take too much risk, but by selling investments that have done well in favour of those that have done badly, you are effectively selling at the top of the market and buying at the bottom. This is the holy grail of investing and something very few investors consistently achieve.”
When you do your portfolio review, also consider any changes in your personal circumstances that might affect the level of risk you can afford to take. For example, starting to draw a retirement income, or going through a divorce or redundancy, may mean you have to dial down your level of risk. So moving out of funds which invest in higher-risk asset classes such as smaller companies or emerging markets could make sense.
Sometimes a fund can make a change to its strategy that increases its risk profile and makes it less suitable for your personal circumstances. For example, Mr Low sold Scottish Mortgage Investment Trust (SMT) out of some client portfolios when it announced plans to increase its allocation to unlisted securities. “We thought that was a complete change in its risk level,” he says. “We felt that it was moving into slightly uncharted territory and it had become a tech investment fund rather than a global investment fund.”
