Underperforming holdings: Hold or sell?

If you’ve invested in the stock and bond market for any amount of time, you’ve likely experienced one or two of your investment holdings losing value over some time period. Occasionally these holdings bounce back quickly, but not always. If some of your holdings seem to be lagging behind others or underperforming the market in general, how long do you wait before purging them from your portfolio?

Owning a diversified portfolio of investments means that at any given time, some holdings will be underperforming others—it’s an enduring aspect of investing, not an anomaly. Understanding why the strategy isn’t currently working will help to determine if it’s time to cut it loose.

Markets go through cycles and shifts where certain sectors and asset classes (large cap stocks, mid cap stocks, international stocks, etc.) are highly favored. Investment strategies that incorporate those areas of the markets will naturally perform well, meaning sectors and asset classes currently out of favor will temper performance in funds with that focus until the next market shift. If you constantly sell out of investments that are currently underperforming due to these normal market cycles, you’ll ensure that you miss out when those strategies take the lead. However if an investment is underperforming irrespective of shifts in the market and economic environment, it may be time to look at the fundamentals.

Loss of Key People
The loss of key people who have managed an investment strategy is not an automatic cause to drop a fund, but it does warrant a thorough review. Some mutual fund managers prove to be integral to the performance of the fund, and their departures can be detrimental to the fund’s process. A new management team might not be able to replicate what’s been done and the fund could suffer for it.

Strategy Change
When a fund shifts in strategy and no longer meets its objective in your portfolio, it can have an impact on the overall performance. For example, a U.S. large cap fund that starts to have a heavier concentration in small cap stocks or even international stocks will affect your asset allocation and risk in your portfolio and can impact performance.

Fees
There are limited things you can control about investing, but how much you pay to own an investment is one of them. A fund’s fee structure has a direct impact on its performance, and the lower the fees, the more you get to keep as an investor. Sometimes underperforming funds experience an increase in fees because money is flowing out of the fund, so hanging on to them ends up costing more and can drag performance down even further.

More Concentrated Holdings
Some mutual funds choose to hold fewer total securities, relying on the performance of a limited number of holdings. This strategy can create both periods of underperformance as well as outperformance. At times, the JNBA Investment Committee will be more patient in riding out volatility with these types of investments.

Take AMG Managers Fairpoint Mid Cap Fund (ABMIX), a fund that we hold in some JNBA portfolios.

Year-to-date it’s ranked near the top in its fund category, but for the one-, three-, and even five-year periods it ranked near the bottom. Its 10-year rank? Back at the top. This fund holds fewer stocks, meaning if one or two of those stocks are negatively impacted by a market shift, the fund as a whole will experience more short-term volatility while those holdings are out of favor. You can see periods of swinging performance in the graph above.

This fund returned 10.03% in 2014, -10.13% in 2015, and then 24.36% in 2016. This three-year stretch illustrates why sometimes the best option is to wait it out. As a long-term holding, we have confidence in the managers and the strategy, and for now, we continue to hold it in our portfolios despite its stretches of underperformance.

Your Own Goals Have Changed
Regardless of a fund’s performance, if your own financial goals have changed, you may be holding funds that are no longer appropriate for you. This is why JNBA communicates regularly with clients to understand goals and objectives on an ongoing basis. By reviewing your asset allocation and capacity to take risk in your portfolio, we can align your investments with your changing objectives.

Underperformance alone is not an automatic reason to sell out of an investment. If we sold out of every asset class that underwhelmed in 2018, we wouldn’t have much left to catch the sharp rebound. Even if an investment has performed poorly for a few years, if the fundamentals are strong, the fund is still managed according to its objective, and it’s still a good fit for your financial goals, sometimes the best answer is to wait for the markets to shift. Short-term volatility is the tradeoff we accept for the kind of returns we expect over the long term.

 

 

Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions.  Moreover, you should not assume that any discussion or information contained in this blog serves as the receipt of, or as a substitute for, personalized investment advice from JNBA Financial Advisors, Inc.

Please see important disclosures information at www.jnba.com/disclosure