When Your Fund Underperforms: 7 Questions to Ask Before You Sell

Underperformance by an actively managed fund in your portfolio is uncomfortable, but it’s not always a sell signal.

Because context matters. Whether a fund is temporarily out of favour, structurally flawed, too expensive, or no longer fit for your portfolio should change your response to underperformance.

Time to Ask Questions 

If you own a portfolio comprising multiple actively managed funds, you’re eventually going to own one that underperforms.

It might be an Australian equities fund that trails the S&P/ASX 200, a global fund that misses a US-led rally, a bond fund that struggles when yields rise, or a thematic ETF that looked compelling when the story was exciting but has since lost momentum.

The temptation is to react by selling the laggard and buying whatever has been working lately.

But wait. That may make you feel better when you next check your portfolio, although it can also turn one period of underperformance into a permanent mistake.

This is a bigger deal than most investors realise.

Morningstar’s ‘Mind the Gap’ research shows that investors, on average, earn 1.2% p.a. less than the funds they own because of poor timing decisions, including buying after strong returns and selling after weak ones.  

If you don’t want to fall victim to this performance gap, it’s important to ask better questions before selling an underperforming fund.

Here are seven that may help:

Question One: What is it underperforming against?

So, your fund is underperforming. But compared with what?

A global shares fund should not be judged against the ASX 200. An Australian small cap fund should not be judged against a large-cap bank-heavy index. A hedged global bond ETF should not be compared with cash. A high-income equity fund should not be judged only by capital growth if part of its return has been paid out as distributions.

The right benchmark is important to understand because markets have been unusually narrow at times.

For example, in recent years, global equity returns have been dominated by large US technology stocks. Against that backdrop, a diversified global manager with less exposure to mega-cap technology may be underperforming the MSCI World Index during that period, even if their portfolio is genuinely diversified and doing exactly what it’s meant to do.

The same applies in Australia. If the banks, miners or a small group of large index weights dominate the market, an actively managed fund that avoids those names in favour of smaller companies can lag badly in the short term.

Hence, your first step is to compare your fund with the right benchmark, peer group and objective it set for itself.

Question Two: Is the underperformance short term or persistent? 

A bad quarter is not the same as a bad decade.

Bear in mind that fund returns move in cycles because investment styles move in cycles.

That means value, growth, quality, income, small caps, emerging markets, listed property and fixed income can each spend long stretches in or out of favour.

The S&P Dow Jones SPIVA Australia Scorecard is useful context here because it shows how hard consistent outperformance can be.  

In 2024, 56% of Australian Equity General funds underperformed the S&P/ASX 200 over one year, while 85% of Global Equity General funds underperformed their benchmark.

Over 15 years, the underperformance rates were much higher, ranging from 58% for Australian Equity Mid- and Small-Cap funds to 95% for Global Equity General funds.

That doesn’t mean actively managed funds should be universally dismissed.

It means investors need evidence supporting why a fund is positioned to resume outperforming longer term.

One weak year may be tolerable. But a repeated inability to meet the benchmark after fees, across different market conditions, deserves a deeper review.

In short, it’s worth asking: Has this fund underperformed because its style is out of favour, or because its process is no longer working?

Question Three: Has the fund’s role in your portfolio changed? 

When you buy an actively managed fund, you’ll be aiming to fulfil a portfolio role designated for that asset class within your asset allocation plan.

For example, a broad Australian ETF may be used as a low-cost core exposure to local shares. A global equity fund may be there for international diversification. A cash ETF may be there for liquidity and capital stability. A fixed income fund may be there for income and downside cushioning. A geared or short ETF may be a tactical tool rather than a long-term core holding.

The problem starts when investors forget why they bought a fund.

For example, a defensive bond fund may disappoint during a period of rising yields, but still provide portfolio diversification when equity markets sell off. A listed property ETF may lag broader equities when interest rates are rising, but still offer exposure to real assets and rental income streams. A sustainable global equity fund may underperform the broader market if excluded sectors such as energy or defence rally strongly.

In other words, a fund may be underperforming, but still doing its assigned job.

The reverse is also true.

A fund may be performing well but no longer serve your plan.

A concentrated technology ETF, for example, may have delivered strong returns but grown into a much larger portion of your portfolio than intended.

That’s a portfolio construction challenge rather than a performance problem.

Question Four: Are the fund’s fees too high? 

As most fund investors will testify, fees matter most when returns disappoint.

Fees are charged whether a fund makes money or not, and may include management fees, performance fees, transaction costs and, in some cases, entry, exit or switching costs.

The upshot is that an actively managed fund charging a 1.2%+ p.a. management fee needs to deliver a service that’s genuinely valuable to justify those costs.

That might be specialist access, proven active management, tax-aware implementation, downside protection, income generation or exposure that’s difficult to replicate cheaply.

In contrast, if a fund is expensive and underperforming, the fee question is likely to evolve into: why not use a lower-cost ETF instead?

Question Five: Has something changed inside the fund? 

Sometimes fund underperformance is normal. Sometimes it’s a warning that change is afoot in the background.

On that note, look for changes in the fund’s investment team, portfolio manager, ownership structure, investment process, asset size, liquidity profile or mandate.

A small-cap fund that becomes much larger may struggle to invest as nimbly as it once did.

A boutique fund that loses its key portfolio manager may no longer be the fund you originally selected.

A strategy that drifts from quality companies into speculative turnaround stocks may be taking risks you didn’t sign up for.

Also check that the fund is sticking to its mandate.

If you bought a diversified income fund and discover it has taken on more credit risk, duration risk or illiquidity than expected, the bigger issue may be suitability.

When asking these questions, useful documents include the fund’s Product Disclosure Statement, target market determination, monthly factsheets, portfolio updates and annual reports.

Question Six: Are you reacting to performance, or to discomfort? 

There’s also an emotional side to managing fund underperformance that’s worth being aware of.

Investors don’t usually panic just because a fund is down 4%.

They tend to panic because a colleague’s fund is up 12%, a friend is talking about AI stocks, or a headline suggests they’re missing the next big opportunity while their fund is languishing.

This is why investor behaviour so often damages returns.

Fear of missing out can push investors to take on more risk than they intend to, and to invest at exactly the wrong moment based on limited or unreliable information.

With these emotional biases vying to override your better judgement, a practical question to ask of your underperforming fund is: Would I buy this fund today, knowing what I know now?

If the answer is yes, recent underperformance may be an opportunity to rebalance.

If the answer is no, ask why.

If the reason is simply recent returns, slow down and think twice.

If the reason is fees, process, risk, liquidity or mandate drift, your concern may be valid.

Question Seven: What would you buy instead? 

Selling is only half an investment decision.

Before exiting an underperforming fund, identify what will replace it and why.

Moving from an active Australian equities fund into a broad Australian ETF may lower fees and simplify your portfolio.

Moving from a thematic ETF into a global equities ETF may improve your portfolio’s diversification.

Moving from an illiquid private asset into a listed income ETF may improve your portfolio liquidity.

But you’ll know the idiom about jumping from the hot pan into the fire.

Switching can also introduce new risks.

A lower-cost index ETF reduces manager risk, but it increases direct exposure to the index’s largest holdings. A higher-yielding income fund may improve cash flow, but could add credit, duration or liquidity risk. A global fund may improve diversification, but currency exposure may become more important.

The replacement should solve a real portfolio problem, rather than simply chasing last year’s winner. 

A Simple Review Framework 

In summary, here are those seven simple questions to ask of your underperforming funds: 

1. Is the fund being compared with the right benchmark? 
2. Has underperformance lasted long enough to be meaningful? 
3. Is the fund still doing the job it was meant to do? 
4. Are fees reasonable for the value being delivered? 
5. Has the manager, mandate, process or risk profile changed? 
6. Is the fund still suitable for your timeframe, tax position and liquidity needs? 
7. What would replace it, and would that improve the portfolio? 

Asking Better Questions Leads to Better Outcomes 

An underperforming fund isn’t automatically a bad fund.

It may be out of favour, misjudged against the wrong benchmark, or playing a defensive role that only becomes obvious when markets change.

But persistent underperformance after fees, especially when combined with mandate drift, high costs, poor communication or a weak long-term record, probably warrants action.

The key is to review underperforming funds from a place of being informed. Look at the benchmark, the portfolio role, the fees, the risks and the replacement option. Then make a portfolio decision, rather than an emotional one. 

Disclaimer: This article is prepared by Simon Turner. It is for educational purposes only. While all reasonable care has been taken by the author in the preparation of this information, the author and InvestmentMarkets (Aust) Pty. Ltd. as publisher take no responsibility for any actions taken based on information contained herein or for any errors or omissions within it. Interested parties should seek independent professional advice prior to acting on any information presented. Please note past performance is not a reliable indicator of future performance.