Five tips for deciding when to sell a fund or investment trust

Fund investors can learn a valuable lesson from Bill Ackman’s swift sale of Netflix, writes Kyle Caldwell.

Star investor Bill Ackman, founder and chief executive of investment trust Pershing Square Holdings (LSE:PSH), received plenty of column inches last week after announcing that he had cut his losses in Netflix Inc (NASDAQ:NFLX), just three months after purchasing shares in the company.

Ackman’s decision to accept an estimated loss of $400 million (£311 million) is not just a valuable lesson for investors who buy shares – but also one for fund and trust investors.

Below, we explain why and suggest other pointers on how to decide whether to sell a fund or trust that isn’t delivering.

Has the strategy changed?

Ackman decided to sell Netflix because his original thesis for buying the streaming giant changed after the company announced that it was planning to alter its subscription model, including corporate advertising. As a result, Ackman said he “lost confidence in our ability to predict the company’s future prospects with a sufficient degree of certainty”.

A change in strategy is a red flag that also applies to fund and trust investors.

However, a fund changing its investment approach is not necessarily a bad move. There will be a reason for the change, and it could lead to improved performance.

But if a fund is no longer doing what you want it to do, for example, if you bought it for income purposes and it is no longer paying dividends, it is probably time to hit the sell button.

• What should I do when a fund performs badly? 
• Why it is important to review your portfolio and how often to do it
• How many funds should I hold in an ISA or SIPP? 

Risk profile

Depending on why you are investing and how long you are investing for, the amount of risk that investors are prepared to stomach tends to change over time.

For example, people entering retirement and drawing income may want to focus strongly on income-producing assets, rather than growth ones.

Make sure your portfolio reflects your needs, which will shift over time.

Understanding underperformance

For many investors, the main reason to consider selling is performance not being up to scratch. When a fund is out of form, it is importanttounderstand why it is underperforming. Doing so will help you to assess whether the fund’s underperformance is likely to be temporary.

If it is because the region it invests in/investment style is out of favour, then a period of subdued short-term performance can perhaps be forgiven. In fact, you may view it as a good time to buy more of the fund if you think prospects for the region it invests in, for example, are likely to improve over time.

However, if it has been a favourable market backdrop for the fund and it has still notably underperformed peers, for example through making some bad stock picks, then investors need to weigh up whether to hold on in the hope that performance improves.

Ultimately, it is a judgement call that only you can make.

Has the fund become too big?

The bigger an active fund becomes, the tougher it is for a fund manager to “move the dial”, as the pool of stocks in which they can build meaningful positions shrinks.

As ever, when assessing fund size risk, it is a case of looking under the bonnet and understanding how the fund invests and its main objective.

Some funds that are set up to invest in smaller companies grow so big that they can invest only in the largest firms in the smaller companies sector. Such funds may even widen their exposure to include medium-sized companies in the FTSE 250 index. This can be cause for concern as the fund manager is straying from their original remit.

• What to invest in when getting started: a beginner’s guide 
• Fund size: how big is too big?
• Funds and investment trusts: how small is too small? 

A big premium

It is generally not a good idea to buy a trust on a high premium (5% or higher) because it tends not to be sustainable over the long term and can turn into a discount when conditions change. 

Consider why the trust is trading on a premium, and then take a view on whether the premium is sustainable.

The premium could reflect an impressive performance by the trust’s underlying holdings, as well as strong interest in either the region or sector it invests in. It could also be down to the way the trusts invests being in favour, such as through investing in assets with inflation-linked income streams.