Underperformance is not just “lower returns.” It is the failure to deliver the risk-adjusted outcome that an asset promises within a reasonable time frame, versus an appropriate benchmark and peer set. Here is the exact framework seasoned advisors in India use across mutual funds, PMS, AIFs, direct equities, and bonds.
1) Define “underperformance” precisely
- Relative: Lags the right benchmark and peer median after fees.
- Risk-adjusted: Lower alpha, Sharpe, or Sortino versus category.
- Persistent: Weakness across rolling periods (not just one bad quarter).
- Purpose-fit: Fails the role it was hired for (e.g., downside protection, income, diversification).
Tip: Always align the benchmark with the mandate and style. Large-cap active funds vs Nifty 100 TRI; corporate bond funds vs corporate bond index; factor funds vs factor indices.
2) The advisor’s metric stack
A) Rolling returns and hit-ratio
- 3-/5-year rolling windows, monthly step.
- Hit-ratio: % of windows beating benchmark and peers.
- Flag: Hit-ratio <50–60% over ≥3 years suggests structural issues.
B) Alpha and consistency bands
- Annualised alpha net of total expense ratio (TER).
- Alpha dispersion: Too volatile alpha implies luck over skill.
- Flag: Negative alpha across 3- and 5-year periods.
C) Risk-adjusted scores
- Sharpe/Sortino: Penalise volatility and downside volatility.
- Ulcer Index & Max Drawdown: Depth and duration of pain matter.
- Time-to-recover: Longer than peers indicates fragility.
D) Style purity and factor exposure
- Style drift: Mid/small exposure creeping into a large-cap fund, value turning growth, etc.
- Tracking error vs stated style: Out-of-character bets raise risk of mandate breach.
E) Cost drag and cash drag
- TER vs category median.
- Excess cash or frequent cash buffers reduce compounding.
- Flag: High TER with no commensurate alpha.
F) Correlation and portfolio role
- Cross-holding correlation: If it rises toward 0.9+ with existing holdings, diversification value collapses.
- Flag: Asset no longer diversifies equity risk or duration risk as intended.
3) Asset-class-specific advisors check
Mutual Funds
- SEBI-defined categories imply clear benchmarks; use Total Return Index (TRI) versions.
- Rolling return heat-maps, quartile ranks, expense ratio, and portfolio turnover.
- Style drift in multi-cap/flexi-cap; credit quality in debt funds.
- Helpful primer on growth metrics: CAGR vs Absolute Returns
PMS (Portfolio Management Services)
- Compare to the mandate-aligned TRI benchmark.
- Position-level attribution: stock selection vs sector allocation.
- Capacity and liquidity: AUM growth hurting execution?
- Learn more: PMS for Investors in India and Active vs Passive PMS
AIFs
- Category discipline: Cat I (startup/infra), Cat II (PE/debt), Cat III (hedge/long-short).
- Downside capture and gross-to-net slippage from fees and costs.
- Valuation policy for unlisted assets and side-pocket usage.
- Context: AIFs vs Mutual Funds and Alternative Investment Funds in India
Direct Equities
- Earnings vs price drift, ROCE/ROE trend, free cash flow, and competitive moat decay.
- Thesis checkpoints: If catalysts fail on timeline, consider exit or resize.
Bonds and Debt Strategies
- Yield vs duration sanity check, credit spread vs rating peers.
- Default/ downgrade probability signals, liquidity in secondary markets.
- For foundations: Corporate Bond Market Guide and Bonds: Beginner’s Guide
4) Red flags that turn “wait” into “act”
- Manager or team turnover without a clear succession.
- Mandate breach or repeated style drift.
- Rising TER or hidden costs with stagnant alpha.
- AUM is ballooning, which dilutes the edge or strains liquidity.
- Governance or compliance events.
- Repeated deep drawdowns and slower recoveries than peers.
5) A practical decision tree that advisors use
- Diagnose
- Confirm benchmark, mandate, peer set.
- Run 3-/5-year rolling, alpha, Sharpe/Sortino, drawdown.
- Check costs, cash, concentration, and style purity.
- Confirm benchmark, mandate, peer set.
- Classify the cause
- Cyclical: Factor is out of favour but intact.
- Structural: Process break, style drift, capacity, governance.
- Cyclical: Factor is out of favour but intact.
- Choose an action
- Repair: Keep, but resize, tighten risk limits, and set review triggers.
- Replace: Switch to a superior peer or passive in the same slot.
- Retire: Exit fully if the mandate no longer fits the IPS.
- Repair: Keep, but resize, tighten risk limits, and set review triggers.
- Execute tax-aware
- Factor LTCG/STCG on equity and indexation rules for debt as applicable.
- Use harvesting and switch-within-family where sensible.
- Related read: Bonds Taxation in India 2025
- Factor LTCG/STCG on equity and indexation rules for debt as applicable.
- Document and monitor
- Record rationale, metrics, thresholds, and time-bound checkpoints.
- Automate a quarterly watchlist review.
- Record rationale, metrics, thresholds, and time-bound checkpoints.
6) Thresholds advisors commonly apply (guidelines, not rules)
- Hit-ratio <50–60% on 3-/5-year rolling vs benchmark.
- Negative alpha on both 3- and 5-year windows.
- Sortino below the peer median and drawdown deeper/longer than category.
- TER in the top quartile for the category with no net alpha edge.
- Persistent style drift beyond the disclosed mandate.
7) Example diagnostics by segment
- Large-cap fund: Lags Nifty 100 TRI on 70% of rolling windows, alpha −1.2% p.a., cash at 8–10%. Action: replace with lower-TER peer or passive; re-test role in asset allocation.
- Cat III long-short AIF: Low net exposure but high drawdown and slow recovery. Action: review gross/net process, hedging efficiency, and costs; resize or retire.
- PMS concentrated portfolio: Attribution shows selection drag in 5 names, driving 80% underperformance. Action: thesis review and position limits; consider staggered exit to manage impact cost.
- Corporate bond fund: Spread not compensating for credit migration risk; turnover and TER are high. Action: shift to a higher-quality duration match.
8) Behaviour matters: avoid false positives
Temporary underperformance can be the price of a sound strategy. Distinguish process-consistent pain from process failure. Useful context: Behavioural Finance for Investors and Risk Management Isn’t Boring—It’s Profitable. Also see: Stay Invested, Stay Wealthy.
9) Advisor’s one-page checklist
- Correct benchmark, mandate, peer set
- 3/5-year rolling returns and hit-ratio
- Alpha, Sharpe, Sortino, drawdown, time-to-recovery
- TER and cash drag
- Style purity; tracking error aligned with mandate
- Portfolio role and correlation fit
- Qualitative review: team, process, capacity, governance
- Tax-aware execution plan and documentation
FAQs
1) How long should I wait before calling an asset “underperforming”?
Use rolling 3- and 5-year evidence. One bad year is inconclusive unless there is a mandate breach or governance issue.
2) Should I switch to a passive fund the moment an active fund lags?
No. Confirm if the style is out of cycle or if the process has broken. If alpha is consistently negative and TER is high, passive is a rational replacement for that slot.
3) How do taxes affect the exit decision?
Examine STCG/LTCG and set tax-aware rebalancing. Harvest losses where possible and consider switches within the fund house if suitable.
4) What’s different for PMS or AIFs?
Deeper position-level attribution, capacity, and liquidity analysis, and a tighter focus on downside capture and gross-to-net slippage.
5) Can an asset be kept even if it underperforms?
Yes, if it still diversifies the portfolio and underperformance is cyclical, with evidence that the process is intact.
Conclusion
Underperformance diagnosis is a process, not a hunch. Use rolling evidence, risk-adjusted metrics, mandate alignment, and tax-aware execution. Document the decision and monitor.
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