Mutual Funds: Redemption situations

There is an old adage "Never fall in love with your stock pick", which I believe is true for mutual fund investments too. But one should be very clear about the pros and cons of redeeming your mutual fund units and the returns that you would end up with. This article is an attempt to make clear the consequences and the situations when you actualise your notional gains. Here are a few consequences you need to have in mind when selling mutual fund units.

Exit Loads

It is important for you to understand the back end load structure of the fund you have invested in before signing the redemption slip! I have always maintained that equity is a long-term initiative and as an investor you need to give it the time to give you the best benefits. But for some unforeseen reason, if you have to redeem earlier, you would have to ensure that the back-end/exit load charged by the fund does not have negative consequences on your returns. For instance, if your are redeeming from a fund which has returned 22 per cent in one year and has a 2 per cent exit load for redemptions within 2 years from date of allotment, your net return would be 19.26 per cent (after an exit load of 2 per cent and 0.25 per cent STT).

Tax structures

Any redemption in the taxman's eyes is considered as a profit or loss making activity. Till you redeem, your gain or loss would only be notional, but the moment you redeem, it becomes actual. You would also need to remember that the taxation structures are different for equity- and debt-based investments.

Outlined below are a few situations when you may consider redemption of your investments in a particular fund:

a. Consistent underperformance
Underperformance by a mutual fund is a relative term. Since a fund is a portfolio of stocks by itself, generally underperformance of a set of stocks is offset by superior performance by a few others. Equity is a long-term investment and it is important for you
not to get worried about lack of performance for a period less than a year. But if your fund is underperforming for more than two years, then it may be time for you to move on. You can always check the fund's performance against a relevant benchmark or track it based on certain performance measures.

b. Change in Fund Manager
You put a certain amount of trust on the ‘person' who manages your fund based on his/her track record, especially where you are not sure of the ‘institutionalised' and proprietary processes the fund commits itself to. Therefore, where you are not sure of the level of institutionalisation of decision-making processes, and feel that a change in the fund manager would mean change in the style of the fund, you may want to re-evaluate your holdings. It may be worthwhile to hold on for maybe a year or so, to track the change in style or performance.

c. Change in the fund's investment strategy
Any investment decision you make would be close to your heart. You would certainly not put your money in a fund if you don't believe in the theme / story behind the investment strategy. But there have been occasions in the past when the fund has changed its investment strategy. In cases where the fund's investment strategy is different from the original goals, you may want to re-evaluate your investment in the particular fund. For instance, when a large cap fund (which is meant to give stability to your portfolio), starts investing in mid or small cap stocks, the risk profile of the fund would obviously change. You would then have to re-evaluate your holding in the fund—if your risk appetite is not for a mid or small cap portfolio, then you might want to liquidate your holding and look at other funds which would suit your needs.

d. Changes in your investment strategy
It is not just the fund that changes its course. You might do it too! Some typical reasons for changes in your investment strategy are:

Changes in your risk appetite: Typically, most first time investors would end up picking a large cap (or blue chip) fund which offers consistency. But once you have tasted success, it is very normal for people to take slightly higher risks to move on to a flexi cap fund. So every time you rebalance your portfolio, you might want to do away with one fund and maybe pick another.

To stick to your original asset allocation pattern: If you want to ensure safety of your investments and to maintain the same risk profile, it is important for you to check your asset allocation pattern. If you choose to maintain your asset allocation pattern, you might have to end up liquidating from one fund and investing in another.

The need to rebalance your portfolio: You can't have a single portfolio all your life.
You would have to re-jig your portfolio once in a while to ensure that your returns are optimal. And as your requirements change, you would need to change your investment avenues, which would prompt shifting your funds between different schemes.

Taxation: Investments in mutual funds can provide significant tax breaks. You may choose to make ‘notional' capital losses or ‘significant' capital gains to offset short-term
gains / losses in your other investments. If you choose to make a capital loss to offset any other capital gain, one may end up having to redeem their investment from a fund.

Redemption of mutual fund units can actually be used to your benefit in creating (or preserving) wealth and should never be done impulsively. You would have invested in a fund with confidence. Unless you are doubly sure or there is an explicit requirement, it is not right to exit on impulse before your objectives are achieved. However, if you are sure that your goals and the funds' goals do not match, it is only better to look for a different fund which would suit your requirement best!