Investors typically spend a great deal of time and effort deciding which fund to buy, but often make the decision to sell a fund in a flash, sometimes after seeing just a few months of poor returns. This can be a big mistake. A period of short-term underperformance should not be taken as an automatic sell signal. The sell decision is a lot more complex than that, and investors who consistently sell at the wrong time are just as likely to experience weak returns as those who buy at the wrong time.
There’s no hard and fast rule for when to sell a fund. Instead, we’ve identified a list of common reasons--from a change in portfolio manager to a spike in assets held in cash--when it makes sense to look more closely at a fund to see if it still belongs in your portfolio. Ideally, the criteria for selling a fund should be established as part of the purchase decision. Barring that, here are six reasons why you may want to consider whether it is time to sell a fund:
Management changes. At some funds, a portfolio manager change can be handled seamlessly. But when the key investment decision-maker leaves and there is no strong backup, it may well be time to sell the fund. Organizational changes at the fund complex can also signal that further investigation is needed. If a group of senior managers leave the firm, that can be a sign of problems at the firm that could lead to poor investment performance.
Performance lags at a time when the market environment is favorable for that strategy. For example, if a large-cap growth fund does badly at a time when big, fast-growing companies are in favor, that’s a red flag. But if underperformance occurs when small-cap value stocks are in vogue, you should consider that factor prior to making a decision.
Actively-managed funds are often more concentrated in specific stocks or sectors than their benchmarks. That means you should expect some underperformance at times. Investors who sell during those natural downturns are at risk of missing out on a potential rebound. That’s a big reason that investors typically experience worse investment results than the returns of the funds they own. Keeping a long-term perspective is a key to investment success, as hard as that can be at times.
Assets in the fund fluctuate. Some strategies–buying micro-cap stocks, for example–don’t work as well when a fund gets very large. If you’re worried your fund is getting too big, check to see if the fund company has a track record of closing funds to new investors when they get unwieldy. If it doesn’t, you may want to consider selling when assets balloon.
Likewise, if the assets in your fund are shrinking, it can trigger problems. Fewer assets mean lower fees earned. If profitability lags, a company may cut staff, which could hurt performance. To understand if asset swings are important, it’s key to be familiar, not just with the fund’s profile, but with the fund company’s financial position as well.
Competition grows. If a number of new funds emerge that are pursuing the same strategy, it can be harder for a fund to outperform. Desired assets may become scarce. Likewise, when those securities fall out of favor, many funds may be selling at the same time, steepening the losses for all of them.
Cash grows. A larger than normal cash position can indicate that a manager is having trouble finding attractive investments to buy. 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.
Tax considerations are favorable. Your own individual tax situation can dictate when it is a good time to sell. Mutual funds distribute their capital gains annually. Talk to your tax advisor about whether you should sell before or after a potential capital gains distribution.
The bottom line: Investors should have a thesis for why they buy a fund – and why they might sell it. For funds available on our investment advisory platform, we have a team of analysts in our Global Investment Manager Analysis (GIMA) group that review and rate funds regularly. Talk with your Morgan Stanley Financial Advisor (or find a Financial Advisor near you using the locator below) to learn more about how our analysts currently view changes going on at mutual funds and find a fund that we can recommend.
Key Asset Class Considerations and Other Risks
Investing in the markets entails the risk of market volatility. The value of all types of investments may increase or decrease over varying time periods.
Neither growth nor value investing guarantees a profit or eliminates risk. The stocks of growth companies can have relatively high valuations. Because of these high valuations, an investment in a growth stock can be more risky than an investment in a company with more modest growth expectations. Not all companies whose stocks are considered to be value stocks are able to turn their business around or successfully employ corrective strategies which would result in stock prices that do not rise as initially expected.
Small- and mid-capitalization companies may lack the financial resources, product diversification and competitive strengths of larger companies. In addition, the securities of small- and mid-capitalization companies may not trade as readily as, and be subject to higher volatility than, those of larger, more established companies.
Global Investment Manager Analysis (GIMA) Focus List, Approved List and Tactical Opportunities List; Watch Policy. GIMA uses two methods to evaluate investment products in applicable advisory programs: Focus (and investment products meeting this standard are described as being on the Focus List) and Approved (and investment products meeting this standard are described as being on the Approved List). In general, Focus entails a more thorough evaluation of an investment product than Approved. Sometimes an investment product may be evaluated using the Focus List process but then placed on the Approved List instead of the Focus List. Investment products may move from the Focus List to the Approved List, or vice versa. GIMA may also determine that an investment product no longer meets the criteria under either process and will no longer be recommended in investment advisory programs (in which case the investment product is given a “Not Approved” status). GIMA has a ‘Watch” policy and may describe a Focus List or Approved List investment product as being on “Watch” if GIMA identifies specific areas that (a) merit further evaluation by GIMA and (b) may, but are not certain to, result in the investment product becoming “Not Approved.” The Watch period depends on the length of time needed for GIMA to conduct its evaluation and for the investment manager or fund to address any concerns. Certain investment products on either the Focus List or Approved List may also be recommended for the Tactical Opportunities List based in part on tactical opportunities existing at a given time. The investment products on the Tactical Opportunities List change over time. For more information on the Focus List, Approved List, Tactical Opportunities List and Watch processes, please see the applicable Form ADV Disclosure Document for Morgan Stanley Wealth Management. You’re Financial Advisor or Private Wealth Advisor can also provide upon request a copy of a publication entitled “Manager Selection Process.”
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