Exiting an Underperforming Equity Mutual Fund

Abraham Cherian
Mar 4
6 min read

Reading time: ~6 minutes

Markets have been flat for the better part of 18 months. The Nifty 50 has delivered near-zero returns since September 2024. Mid-caps and small-caps have fared even worse. Then came the geopolitical gut-punch — steep US tariffs on Indian goods, first at 25%, then escalating further into a war in the Gulf Region — sending markets into a sharp short-term crash. Your portfolio is red. Your XIRR, which was a proud 18% two years ago, has slipped to 13% or lower. Naturally, the question arises: should I exit?

The answer is nuanced — and getting it wrong is expensive. Let's break this down clearly.

"Stay Invested" Doesn't Mean What You Think

Most investors hear "stay invested" and interpret it as: don't touch anything, just wait. That's a misreading.

"Stay invested" means stay in the asset class — not necessarily in the same scheme. There is a meaningful difference between saying, "I believe equity will deliver over the long term" and saying, "I believe this particular fund will deliver." The former is backed by decades of data. The latter depends on fund management quality, market cycle fit, and investment philosophy.

Think of it like this: you're at an airport check-in. Your original queue is moving slowly, and you've been standing there for 15 minutes. There's another queue for the same destination that is clearly moving faster. Staying loyal to a bad queue doesn't recover the 15 minutes you already lost — but shifting to the faster one gets you to the same destination much sooner.

The takeaway: Loyalty to an underperforming scheme is not a virtue. Loyalty to your asset class is.

The Market Context: Time Correction, Not Collapse

Before we talk about what to do, let's establish what is actually happening in the market.

This is not a structural collapse. This is a time correction — a phase where valuations that ran ahead of earnings are being corrected, not through a crash, but through stagnation. The Nifty 50 has been range-bound since September 2024, a pattern India has seen before. Between 1998 and 2003 — a full five years — the market did almost nothing. Investors who exited in frustration missed the massive bull run that followed.

The recent tariff crisis and war in the Gulf region triggered by the Trump administration added a sharp shock on top of an already tired market. Geopolitical events like these always feel permanent in the moment. History tells a different story — COVID, the 2015 Chinese slowdown, the 2008 global crisis. Every one of those felt like "the end," and every one of them passed.

The takeaway: Recognize the type of market you are in. Flat + occasional crash ≠ reason to panic. It may actually be the perfect moment to make smart switches within equity.

When Is It Time to Switch — Within the Same Asset Class?

A flat market is, counterintuitively, an excellent time to review your fund lineup — because the tax cost of switching is lower (gains are compressed or negative) and you're buying into the replacement fund at a lower price.

Here's how to assess whether a switch makes sense:

1. How long has the scheme been underperforming? One bad quarter means nothing. Even a bad year can be market-related, not fund-related. But if a scheme has consistently underperformed its benchmark and peer group for 1.5 to 2 years, that's a signal worth acting on.

2. Is it underperforming on rolling returns — not just recent returns? Point-to-point returns are misleading. A fund that looks great today may just be riding the current market trend. Rolling returns — measured across 3-year, 5-year, or 10-year windows over different market cycles — tell you whether the fund is genuinely good or just lucky. Ask your advisor to show you rolling return data before making a decision.

3. Is the underperformance threatening your goal? If you've planned for a 12% return over 10 years, and your fund has historically delivered 14-17% on rolling returns, you have a buffer. Temporary underperformance isn't a crisis. But if the fund is structurally broken — like certain quant funds that used algorithms tuned to bull markets and now struggle in choppy sideways conditions — that's a different problem.

4. Is your goal near or far? If you need the money in 1-2 years, this is not the time to restructure. Stay put, let the market recover a bit, and use the corpus at the time of your goal. Switching now means paying tax (if in profit), disrupting compounding, and resetting your clock. Not worth it.

If the goal is 7-10 years away, a switch to a better-performing fund in the same category makes complete sense.

The Special Case: Your Fund Is in Negative Returns

This one is clear-cut.

If a scheme is giving you negative returns, there is no tax liability — no LTCG, no STCG. There's no reason to stay. Take that money, move it into a better-performing scheme in the same asset class (say, a well-rated flexi-cap or large-cap fund), and wait for the recovery. Instead of recovering from -10% in a mediocre fund, you're now positioned to grow from the entry point in a better fund.

The mental hurdle here is that investors feel the loss becomes real when they exit. It doesn't. The loss is already baked in. Staying in a bad fund while the market recovers just means you recover less than you would have in a better fund. The loss is notional until the day you actually pull money out and spend it. Switching to a better equity fund keeps the loss notional while improving your recovery trajectory.

The Dangerous Alternative: Panic-Selling into Debt or Gold

Now let's talk about what you should not do — and why so many investors do it anyway.

When markets fall sharply, the instinct is to "protect" your money by moving to debt funds or gold. It feels rational. It is not.

Here's why:

When you exit equity and enter debt, you crystallise your equity loss. It stops being notional and becomes real.
Debt or gold then needs to give you returns comparable to equity just to recover what you lost. Historically, they don't.
When equity eventually recovers — and it always has — you are no longer in it. You've locked in the loss and missed the upside.

Panic-driven asset class switching is the most expensive mistake in personal finance. It's the difference between a turbulence-induced reflex to exit a flight mid-journey, versus understanding that turbulence is normal and staying in your seat.

Switching funds within equity = repositioning your seat on the same flight.

Exiting equity for debt = getting off the plane mid-air.

These are not the same action, even if the trigger (fear) is the same.

The Tax Angle: Use This Market Intelligently

A low or negative market has one silver lining — it's a great time to clean up your tax position:

If your funds are in a loss, exit them. Realized losses can be carried forward for 7 years and offset against future gains, reducing your tax bill significantly.
If some funds are in profit and some in loss, consider exiting both in the same year. The losses offset the gains, potentially reducing your LTCG liability to zero.
After exiting the loss-making funds, immediately reinvest in better-performing schemes in the same category. You haven't left the market — you've just cleaned house and upgraded your holdings.
Avoid over-engineering the process. Don't build strategies with too many assumptions ("market will recover in 5 months, so I'll wait to redeem, then reinvest...") — that kind of complexity introduces execution risk.

The goal is simple: use the low-return environment to compress the tax cost of switching, reduce your scheme count (ideally from 20-30 schemes down to 5-6 solid ones), and position yourself well for the next market upswing.

Thumb Rules for Switching Equity Funds

Keep this list on hand the next time markets make you anxious:

"Stay invested" = stay in the asset class, not the same scheme. Equity is your thesis; the fund is just the vehicle.
Evaluate on rolling returns, not recent performance. Point-to-point is noise. Rolling returns across market cycles are the signal.
1.5–2 years of underperformance = time for a review. One bad year is not enough. Persistent underperformance is a red flag.
Negative returns = exit without hesitation. No tax cost, no reason to stay in a losing fund.
Goal nearby (under 2 years)? Don't switch. Use the corpus at the time of the goal, regardless of short-term underperformance.
Goal far away (7+ years)? Switch freely. Time is your greatest asset — deploy it in the best possible fund.
Never shift to debt or gold out of fear. That crystallises loss and locks you out of the recovery.
Use market lows for tax harvesting. Exit loss-making schemes, offset against gains, carry forward remaining losses.
Reduce clutter. A well-structured portfolio of 5-6 funds beats 25-30 overlapping ones every time.
Use your planning benchmark as your anchor. If you planned for 12% and your fund's historical rolling minimum is 14%, short-term dips are not a crisis — they're part of the plan.

The market will recover. It always does. The question is not whether equity will reward patience — it's whether you are in the right equity scheme when it does. Audit your portfolio now, while the cost of switching is low. That is not panic. That is precision.

Disclaimer: This content is for informational purposes only and does not constitute financial or tax advice. Investments in the securities market are subject to market risks. Read all the related documents carefully before investing.