Sunday, May 4, 2008

Mutual Funds 4 - Exit Points (Sell / Switch)

As in any investments, the approach should cover Exit Points - either to stop-loss, lock-in profits or rebalance asset allocation.

Given that a fund is performing badly (vs. investment in other funds during that period OR vs. other funds in the same sector) after 1 year-ish of holding, look into switching to a fund which I'd think would better performing for the coming year or two.

So far, I'm "lucky" enough to do this only once so far and it is due to "testing water" of a property focussed fund BEFORE the subprime issue.

Lock-in Profits:
Sell or switch when a investment transaction hits a profit target

When an asset type is more than X% (usually 5%) of planned allocation

Personal approach:
Personally, my long term expected average returns pa. from equity funds is 10% and bond funds 5%. Why these figures? Heheh - based on statistics of an index fund (10 years) which I have access to daily data since launched + others, the average pa. returns ranges from 8% pa to 12% pa.

Thus, my approach to locking-in is:
When fund profits hit abnormal returns pa. (in my case 16%+ pa for equity funds and 8%+ for bond funds)
AND cost + expected profits are >= $2,500 (to ensure that the switching cost is 1% or lower)
Switch cost + expected profits to a different country/sector or asset (equity to bond or vice-versa)
AND leave abnormal profits to run (heard of "cut losses short, let profits run" ? ;P)

If a particular transaction has already locked-in profits
AND hits abnormal returns pa.
AND the 50% of the profit run is >= $2,500
Switch 66.67% (2/3 lar) profits to a different country/sector or asset (equity to bond or vice-versa)
AND leave 33.33% (1/3 lar) profits to run (again I take profits and "cut losses short, let profits run" here)

Based on my own tracking PER BUY TRANSACTION and dividing reinvested dividends per buy transactions, most of my transactions' returns hitting above 16% pa will tend to drop after that. My Public Regional Sector and Prudential SmallCap hit >=20%+ pa returns and pulled back within 3 to 4 months after that. Thus, my personal approach helps me:
- take expected profits and cost back
- while leaving enough to "let the profits run" (in my case, abnormal profits)
- control downturns due to crazy exhuberant market getting logical (called a "market correction)
- rebalancing

I switch rather than sell back to the Funds House / redeem because I do not need the $ to live on, thus, I'd rather reinvest at NAV. FYI - selling/redeeming for cash AND buying back in incurs commission charges).