How to Deal With Laggards in Your Mutual Fund Portfolio

The process of removing laggards from your portfolio may appear overwhelming, but all you need is the will and a plan to get started.

What to look for when assessing your portfolio

All well-stocked portfolios, according to experts, should include some funds that are growth-oriented and those that are value-oriented. However, it isn't always a smart idea to over-rely on a single investing strategy simply because it's performed well previously. For instance, there have been moments in the past when growth didn't work out.

What caused the performance slump?

You need to know the reasons why a fund hasn't performed well before deciding whether or not to abandon it. Rarely are all investment vehicles equally successful at any particular moment. At some point, the underdogs will win while the superstars will go through a hard patch.

Managing a fund's cash position also has a bearing on its performance. Equity mutual funds maintain a small amount of cash in their holdings in order to meet redemption requests. In a bear market, this cash component might help you halt your decline, but in a bull market, it can actually impair your performance.

Equity portfolio diversification should include geographical, market capitalization, style, and fund size considerations. As long as you remain patient and consistent with your investments, your portfolio will be able to produce reasonable risk-adjusted returns over time.

Strategies for tackling laggards

Manage your emotional investments

Investors are more likely to choose stocks or other assets they are familiar with. Most of them could be investments that have been suggested by friends and family or that have performed well in the past. Some people may also hold on to assets because of the sentimental value they attach to them rather than their performance.

Past results, however, aren't a great indicator of future profits. In the belief that it would one day pay off, investors often find themselves clinging on to risky assets out of sheer hopelessness. Your goal should be to detach all emotion from your investment decision-making.

Rebalance the assets in your portfolio

If you've done your research on the assets you own, selling high and buying low is an excellent way to reinvest the earnings from your top-performing investments. Laggards that have a good chance of growing in the future should be kept, while those with an unclear future should be sold. Maintain an eye on opportunity costs during rebalancing.

Consider recurring cycles

If you're a trader, you may often forget that markets go through cycles. An in-depth examination of the market's many stages is required to recognize these cycles for each asset type.

Some investors may consider some of their asset investments as laggards based on a five or ten-year cycle, for example. Equity markets are expected to perform well in the long run since there is no particular asset class that can consistently be a winner or loser. You may avoid incurring losses at "bottom-out," right before a rally, by understanding the cyclical performance of each asset type.

Breaking free from asset traps

Once you've done your homework to identify your portfolio's laggards and eliminate them, you need to be able to make investment decisions without regard to what you've had previously. In order to avoid being sucked into an underperforming asset class and ending up back where you started, maintain a distance between your acquisitions and sales. For instance,  it would be pointless to reinvest in the real estate sector if you had sold a real estate asset that was bringing down your portfolio because the sector has been stagnant.

Use a Systematic Transfer Plan (STP) and Systematic Investment Plan (SIP)

Using an STP, you can transfer a set number of units from one scheme to another within the same mutual fund on a regular basis. Depending on the state of the market, you may want to switch from equity to a debt-based STP or vice versa.

All SIPs and STPs are based on the principle of spreading your investments out over time in order to minimize your exposure to market fluctuations. Your SIPs in the older fund will continue while your investments in the newer fund are being averaged out. As a result, going forward, there will be no use in continuing to average it. The new fund is where you should start your SIPs, while the old fund is where you should transfer your accumulated funds in one lump sum.

Supplement your SIPs during market downturns

Strong market corrections, such as the one caused by the COVID pandemic, may cause many investors to quit their SIPs for fear of more market drops and losses.  However, the strong market corrections and negative market periods provide the tremendous long-term potential for wealth generation.

Because of such downturns, fund managers are able to invest in high-quality stocks at incredibly low prices. Investors should thus not only maintain their SIPs throughout such market phases in order to average their investment costs, but they should also aim to top up their SIPs with lump-sum contributions in a phased manner in order to average their investment costs even more.

Conduct routine reviews of the performance of your investment fund

When investing in mutual funds, it's crucial to evaluate how they have fared on a regular basis. It will help you to see how your funds compare to their peers and benchmark indexes in different market scenarios. For instance, it may be a good time to look for new funds if your current investments have consistently underperformed their peers over the last three years.

In summary

You need to know which of your investments is lagging behind. A fund may be considered a laggard if, during the past three years, it has persistently underperformed both its peers and the benchmark. There are a lot of things to consider while deciding which schemes to get rid of. But investors need to avoid comparing their stock portfolios to other asset groups that are under different market circumstances.