Should you exit a lagging mutual fund?
How to tell the difference between a cycle and a warning sign
“I’ve held this fund for three years and it’s underperforming. Should I exit?” It’s a common concern. One that sparks doubt even in seasoned investors. On the surface, the question is logical. But the answer isn’t just data-driven. It’s behavioral. Because here’s the truth:
A fund’s short-term underperformance isn’t always a problem. Sometimes, it’s just the cost of following a sound process.
Let’s understand how to differentiate between a temporary lag and a real problem.
The cost of a long-term strategy
Every fund, no matter how well managed, will go through phases of underperformance. The problem is most investors don’t expect that. They assume:
Good fund = Always near the top of performance charts
But that expectation itself is flawed. Even the best funds fall behind temporarily when their style goes out of favor. And if you don’t recognize this, you’ll exit at exactly the wrong time.
First, understand the three core reasons funds underperform
1. Style headwinds
Funds follow defined styles: growth, value, quality, or a blend. Each style performs differently depending on market conditions.
Growth lags in sideways markets
Value underwhelms in bull runs
Quality trails when markets chase momentum
If your fund sticks to its process, but the market is rewarding a different style, it’s not mismanagement. It’s a cycle. And it will turn.
2. Strategy drift
A bigger concern is when the fund stops following its original process. This often happens after:
A rapid increase in AUM
Change in fund manager or AMC leadership
Shift in investor expectations
Suddenly, the fund tries to be everything at once: a bit of growth, a bit of value, a bit of momentum. But without clear conviction in any direction. This is a red flag.
Because when the process breaks, underperformance isn’t a phase it becomes the new norm.
3. Team or philosophy changes
Always check: Is the same person managing the fund? Has the fund house changed its approach in recent years? Is there a shift in portfolio turnover or asset allocation?
If the answers point to instability, then the underperformance might be structural.
So how do you know when to stay vs. when to exit?
Ask these three questions:
a) Is the fund’s style consistent?
If it still follows the same process, it may just need time.
b) Are long-term rolling returns intact?
Check 3-year and 5-year rolling returns, not just point-to-point data.
c) Does the manager’s commentary show conviction?
Read their quarterly notes. Look for discipline, not excuses.
If you get consistent answers here, the lag is likely temporary. But if the style, Portfolio, and tone have all shifted you may need to reconsider.
Final thought
Many investors lose money not because their fund failed. But because they couldn’t stay the course when it temporarily underperformed.
Your ability to hold through underperformance is often what separates success from regret.
So don’t just ask, “Has the fund underperformed?” Ask instead:
Has the process stayed intact?
Is the manager showing conviction?
Can I live with this style through cycles?
If yes, stay the course. If no, exit with intention not emotion.
Coming up next on Stock Market Explainers
Why investors underperform the very funds they hold
How to build a 3-fund portfolio that can last 15+ years
The psychology of regret and how to manage it
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