Eight reasons to dump a fund

Published in the Money Magazine, February 2012 by Peter Freeman

Disappointing returns from many managed funds over the past five years have prompted some investors to cross them off their line-up of possible investments.

For some this has simply meant diverting new money elsewhere.

Others have taken more drastic action, selling most, if not all, of their existing stake in managed funds.

Justine Gorman, a managed funds analyst and head of Australian equities at S&P Australia, says she understands the temptation to react this way but in her view - and that of other investment experts - dumping a fund due to poor short-term returns and continuing uncertainty is likely to be a mistake.

"There are definitely a number of good reasons why you might want to get out of a fund, but even these have to be carefully assessed before you decide to sell," she says.

What follows is an outline of eight key reasons why an investor might sell out of a managed fund, combined with an attempt to rate each reason as good, bad or possible.

1. Big slump in the market values- Bad reason

Many investors panic when share markets slump.

Fearful of further falls, some respond by selling out, either immediately or after the downward slide appears to be intensifying.

This is a bad reason to sell your managed funds, in part because these are mainly growth investments that should not be assessed on the basis of what might turn out to be a short term setback.

Many people follow the herd rather than a solid, long-term strategy," says Dale Gillham, head of investment services group Wealth Within.

"If you develop the latter approach, you should be able to ride out a big market fall without panicking."

2. Poor short-term performance- Bad reason

No fund, managed or super, should be judged solely on its short-term performance, which roughly equates to returns over the past few years.

Alex Dun n in, research director at Rainmaker Information Services, says even a fund generating poor short-term returns relative to its rivals usually deserves the chance to recover.

"Unless there is some other reason to move your money away from the fund, you should treat poor short-term returns merely as a reason to keep a close eye on the fund, not as a reason to sell out of it straight away," he adds.

3. Fund manager is take over- Possible reason

A good reason to invest in a particular managed fund is because you respect the people, processes and performance of the investment management group that runs it.

Being taken over by, or A merger with, another group doesn't mean a change for the worse, hut they could.

"Another issue is the risk that a lot of management time will be taken up with merging the two operations," says S&P's Gorman.

At the very least you should put the fund on hold and monitor the situation. Some could reasonably go further and switch their money to a different fund.

4. Investment strategy changes- Possible reason

An example of a radical change to a fund's investment strategy would be when it moves beyond focusing on the shares of major industrial companies to include smaller and emerging companies.

This would be quite a fundamental change which, for some investors, would justify switching out of the fund.

According to Wealth Within's Gillham, whether a change of strategy should prompt you to shift out of a fund will depend on the extent of the change and your needs.

In all cases, a change of investment strategy demands a careful reassessment of the fund.

5. Poor longer-term performance- Good reason

If a fund has generated a poor long-term performance relative to equivalent funds, this is usually a good reason to dump it.

Dunnin of Rainmaker says a fund whose returns are generally in the bottom performance.

It is rarely sensible to let the desire to save on tax and fees drive your investment decisions./p>

Despite this, both need to be taken into account when deciding to sell out of a managed fund.

Capital gains tax can be an issue, especially if you have held a fund for some years and so have built up substantial unrealised gains.

But, according to Rainmaker's Alex Dunnin, provided you have good reasons to sell your decision shouldn't be affected by having to pay capital gains tax.

About the only consideration is whether you can juggle the timing of your sale to minimise its impact. 

For example, if you are about to retire it is better to sell when your marginal tax rate is lower.

Similarly, taking capital gains on managed funds held in a self-managed super fund is best delayed until you start a tax free, account-based pension.

While most managed funds don't charge exit fees, some do.

You need to check and, if fees are substantial and your decision to sell is marginal, you might decide to hold quartile relative to other similar funds over the past three to four years almost certainly has fundamental problems with its people or investment processes, or possibly both.

Unless there is a specific reason why you believe it is worth holding on, it should he dumped.

6. Key investment experts leave- Possible reason

Gillham says there is no hard-and-fast rule about what to do when key personnel managing a fund leave.

"While a few funds do have a standout investment manager whose departure might well prompt you to shift your money elsewhere, as a general rule a fund manager will experience two or three changes in key personnel over a 10-year period," he says.

"Provided the firm is well run and has a sound reputation, anyone who departs is likely to have a quality replacement who, in most cases, will be able to maintain the fund's long-term returns."

7. You experience a major life change- Good reason

Perhaps the biggest life change that justifies a review of your investments is retirement.

At this point it can make good sense to shift your focus to generating income rather than chasing capital growth.

"Reviewing your investments because you have just retired is sensible, and can be a good reason why you decide to sell a fund," says Dunnin.

8. You shift to index funds- Possible reason

Gorman doesn't think this is a particularly good reason, arguing that active fund managers at least have the ability to resist the impact of a big market sell-off whereas index funds simply fall along with the market as a whole.

It can make reasonable financial sense for an investor to opt for low-cost index funds to build long-term wealth.

If so, dumping your actively managed funds is a logical consequence.

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