How To Know When It’s Time To Sell A Fund?

One of the trickiest things to get right as an investor is judging when it is the right time to sell assets. You don’t want to do it too soon and end up locking in a loss or receding gain before the fund recovers to move in the right direction again. But it also doesn’t make sense to go down with a sinking ship because you are determined to hold out until the last in the hope things will turn around.

Advice on how to handle the sale of investments can also seem contradictory. We’re often told one of the golden rules of long-term investing is to ignore short term volatility and not make kneejerk decisions to sell investments because they have experienced a drop in value.

The argument is a sound one and is based on the principle that markets move up and down and market sentiment towards particular companies is often short term and cyclical. If you’ve done your homework and decided to invest in a fund for all the right reasons, it is counterproductive to your long-term investment strategy to sell off at the first sign of some volatility.

But it’s also foolish to blindly hold onto investments, even if we they were originally selected for all the right reasons. Sometimes market conditions change to undermine what was once a sound investment strategy. Or both the fund manager and investors bet on an outcome that made sense but ultimately didn’t work out as expected.

There are a huge number of factors that can influence the outcome of a particular investment. It’s not realistic to expect that any investor or investments manager will always anticipate them all accurately.

Investing can, in some regards, be compared to playing poker. Even a great hand played sensibly doesn’t always win. There’s still an element of chance around how unknowns will play out and they don’t always play out favourably. Long term success is about diversifying risk and playing the odds over many hands (investments). If that is done consistently then an investor can expect to come out ahead. Even if that inevitably entails taking some losses along the way.

And to extend the poker analogy, achieving long term investment success is just as much about correctly managing losses from investments that don’t work out as it is about the number and size of the gains from those that do. Without putting your capital on the line and risking some losses, it’s also impossible to record the gains. Investing is, after all, inherently a risk-based endeavour.

And just as importantly, as investors we also need to make good calls on when to sell investments that have done well for us. That often means selling when an investment is still moving in the right direction, possibly missing out on additional gains. But if we hold on and try to time the absolutely optimal moment to sell, we run a significant risk of being caught out and losing out on some, and sometimes a good chunk, of returns we could have locked in by selling a little earlier.

Selling an investment at the right time is, therefore, relevant in two different contexts:

• Cutting losses
• Locking in returns

However, in both circumstances, many of the signs that are good indicators of when to sell are the same.

The Tell-Tale Signs It’s A Good Time To Sell A Fund

The concept that not every investment will work out and we’ll need to sometimes take a decision on when to lock in and cut our losses is one most investors appreciate and, in theory, understand. The harder part is actually taking that decision and acting on it at the right time.

One recent high-profile example of a fund that have gone sour for investors include the Woodford Equity Income fund, which was first suspended and ultimately wound up. Investors locked in when the fund was suspended are still waiting for part of their money back, with the fund’s administrators struggling to sell illiquid and poorly performing assets.

And when the final tranche of the liquidated assets is paid out to investors, those that bought into the fund at the height of its value, soon after it was launched and optimism high, are likely to see total losses of around 40% on their initial capital invested.

More recently, the steady fall in the value of the Invesco Income and High Income funds managed by Mark Woodford protégé Mark Barnett before he was sacked last month, has also seen many investors wondering if they should cut their losses and sell or hold on in the hope of things turning around.

What Are The Signs It’s Time To Sell An Underperforming Fund?

Judging when to sell a fund is not an exact science. But if you keep a careful eye on these signs, you should get it right more often than not:

Performance Has Declined

The most obvious sign it is time to sell a fund has to be poor performance. But at what point does declining performance move from ‘market fluctuations’ or the fact a fund is invested in assets that need some patience to come good, to a dangerous looking negative trend that means it’s time to abandon ship?

You should always take into consideration the nature of the fund you are invested in. But a good rule of thumb is to seriously consider cutting and running if a fund underperforms its benchmark over two consecutive six-month periods.

Funds with a value investment strategy are slightly trickier because their job is to find underperforming assets and buy into them while they are still undervalued by markets. At what point markets will also come to the conclusion assets are undervalued and push their price back up, often isn’t something that runs to a reliable timetable.

In this case, the decision on when to sell will come down to if the fund’s performance is falling short of your expectations.

The Number Of Assets A Fund Is Invested In Increases Significantly

It often happens that funds can become a victim of their own success and see their performance start to decline after a period of outperformance. The most common factor behind that tendency is inflows of cash from new investors meaning the fund manager has to increase the number of assets they invest in. It may not make strategic sense to increase the exposure to existing assets so instead new opportunities are sought out.

Having too much money to invest, and having to spread it out across a greater number of assets can make the fund harder to manage. It can also see previously strict investment criteria relaxed because the fund manager has to invest the cash somewhere.

The Fund Manager Has A Change Of Style

A third warning sign can be the fund manager changing their investment strategy and/or style. This can indicate a move away from what they have excelled at in the past, which is not always a good idea. Some fund managers successfully reinvent themselves and the best evolve throughout their career alongside markets, which also do not remain constant forever.

But a change of strategy or style is also the point when many previously successful fund managers start to struggle and do less well than they have historically. If you do spot a change of direction in a fund you are invested in, you should certainly keep a close eye on developments going forward.

Institutional Investors Are Selling A Fund

A major warning sign a fund is heading in the wrong direction is that institutional investors, such as funds-of-funds, start to sell out. For example, ahead of the suspension of the Woodford funds, it was well publicised that the Jupiter multi-manager or funds-of-funds, were selling out of them.

Following the lead of Jupiter’s team would still have been late. Funds-of-funds tend not to sell out of their holdings on a whim. But it wouldn’t have been too late and a much better result than being caught locked in the fund at its suspension.

There is no definitive answer as to when a fund should be sold. But watching out and taking heed of these signs will certainly mean you have a much better record at making the right sell calls at the right time.