Make sure none of these funds are in your portfolio

7 min Read Published: 18 Nov 2015

One of the hardest decisions facing investors is knowing when to ditch a fund within their investment portfolio. It is human nature to even hang on to underperforming funds hoping that they will turn around, Hanging on to underperforming funds will decimate your portfolio returns.

The trouble is how do you know when a fund should be ditched or when it is just temporarily underperforming? No fund manager will perform well in all market conditions so it isn't a simple case of just selling funds that have lost money in the short term. Many funds will bounce back when market conditions changes. You need to be much more strategic than that. So below I tell you how to quickly review your portfolio and work out the funds to sell.

Step 1 - Make sure none of these funds are in your portfolio

It may be hard to believe but research has shown that over £17.6 billion of investors money is invested in perennial underperforming funds, so called 'dog funds'. Therefore there's a good chance that most investors have at least one of these funds in their portfolio. These aren't just funds that fail to beat their peers but also fail to beat their own chosen benchmarks over time. Yet there is no system by which these fund managers or investment houses are held to account. As such they continually promote these underperforming funds relying on consumer inertia to not ditch them. in fact the average investor holds a fund for more than 7 years!. It's important that you don't let the investment fund houses exploit you in the same way.

Fortunately you can currently download the full list of funds which the research identified as funds to avoid holding in your portfolio (the research calls them 'dog funds'). Download the guide and then check whether any of the funds within your portfolio are on the list. Helpfully the guide also suggests alternative funds to switch into should you have one of the 'dog funds' in your portfolio.

Step 2 - How to check the rest of your portfolio

In order to maximise your portfolio returns it is sensible to nip potential problems in the bud. Or in other words, review the rest of your portfolio and get rid of any funds that are likely to end up in the aforementioned list of 'funds to avoid'. To help you here is a simple process I used when reviewing client portfolios worth millions of pounds to identify funds to consider selling:

  1. Build a watchlist. If a fund is starting to lose you money or underperform its peers in the same sector then I would put the fund on a watchlist and monitor its performance to see if things improves.
  2. Find out why the fund is underperforming.  Read any published commentary by the fund manager. Google the fund's name and go into either news on Google or search the whole Web. Then refine the search results to within the last month, and you will likely find an article with the manager being interviewed or a press release explaining why the fund has performed as it has. If you find out that the fund is underperforming for a valid reason, such as it is defensively run which was a reason why you liked the fund in the first place, then I wouldn't necessarily ditch it. Decide whether you actually like what they're doing and whether the fund is adding diversification to your portfolio
  3. Check the fund's Beta statistic . Beta is a measure of how a fund's performance tracks its chosen benchmarks. The figure goes between -1 or 1. So if the fund has a beta of 1 it just tracks its index. A beta of -1 means the fund's performance moves in the opposite direction to that of its benchmark. If your portfolio contains a fund that isn't meant to be a tracker, that's still effectively tracking the market, think about switching out of it. That's because you're paying expensive charges for what is a closet tracker. You'd be better off buying a cheap index tracking ETF if that is what you want.
  4. Check the fund's Sharpe ratio which can be found online. The sharpe ratio shows how much extra return a manager makes for the level of risk they are taking. Look at that sharpe ratio and the higher that number the better.

If you check all the above you will have a shortlist of funds whose position in your portfolio should be reconsidered.

Step 3 - The final step

The reason why these underperforming funds are able to grow to such enormous sizes is because:

  • they are heavily promoted by banks and some financial advisers
  • investors (or their advisers) do not regularly review their fund choices

That is why it is important have an investment process. In doing so if you're regularly reviewing your portfolio, you'll never get to the point of having to decide whether to sell a fund or not. Instead you will continually review your fund selection, in line with your investment process, weeding out the funds to sell and buy as you go along.

So what is the best investment process to use? I show you what that is in a short email series in which I highlight the simple processes used by professional fund managers which you can use too.

 

(Photo by Stuart Miles via FreeDigitalPhotos.net)

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