Mutual Funds Portfolio Turnover Ratio Explained
Mutual Fund Portfolio Turnover Ratio is a measure that denotes the percentage of equity Mutual Fund’s holdings which have been replaced during the last year. In other words, it is the frequency with which the portfolio is churned over. On Kuvera, you can find the Portfolio Turnover for equity funds in the fund’s details page on the “Other” tab for e.g ICICI Prudential Smallcap Growth Direct Plan
Portfolio Turnover Ratio = (Lower of total securities purchased or sold) / (Average AUM)
For example – Equity Mutual Fund ABC purchased shares worth INR 1500 crores and sold shares worth 2000 crores in 2018. The average AUM for the Fund for the year stood at 6000 crores. The Portfolio Turnover Ratio of the fund is thus 25%, signifying a churning over of one-fourth of the assets of Fund ABC.
Impact and significance
Every purchase and sale transaction in the stock market involves a cost. Thus, although the trading is carried out by the Fund Manager for the Mutual Fund, the cost is borne by the investor. Higher trading would mean higher costs and in turn, lower returns.
A Fund manager’s strategy can be gauged by looking at the Portfolio Turnover Ratio. A low turnover ratio (10-30%) would indicate a buy and hold strategy. It also signifies the conviction of the Fund Manager in his selection of stocks. High Portfolio Turnover Ratio (100% and more) indicates aggressive trading and will add to the costs.
Sometimes, a sudden change in the Portfolio Turnover Ratio means a change in the Fund Manager, who would follow his own agenda. It might also indicate a shift in the strategy of the fund. In an up-trending market, the Fund Manager would try to trade more owing to the available opportunities. In a volatile market, though, s/he might consider it prudent to sit back and wait it out.
How to use Portfolio Turnover Ratio
A high Portfolio Turnover Ratio results in a higher expense ratio. It is considered to be good if it can generate high returns. However, if the turnover ratio is rising (and hence the expense ratio) but the performance is consistently going down, then the investor should monitor it closely and take action.
For an aggressive investor, active investing and consequent high turnover ratio might look like a good idea. However, for a passive investor, who likes to sit tight and invest for the long term, index funds would be an ideal choice.
It is important to observe Portfolio Turnover Ratio during bearish or flat conditions as during a rising market, even very high turnover ratio would yield good results.
Portfolio Turnover Ratio can be used as a qualitative measure for comparing similar funds or two funds from the same category and thus in assessing the Fund Manager’s overall strategy.
Like all other parameters, Portfolio Turnover Ratio cannot be used in isolation and should be used in conjunction with other risk and return measures.
Experience conclusively shows that index-fund buyers are likely to obtain results exceeding those of the typical fund manager, whose large advisory fees and substantial portfolio turnover tend to reduce investment yields. Many people will find the guarantee of playing the stock-market game at par every round a very attractive one. The index fund is a sensible, serviceable method for obtaining the market’s rate of return with absolutely no effort and minimal expense.
: Burton Malkiel
Some Rules of Thumb
- Index funds tend to have a low turnover ratio
- Portfolio Turnover Ratio is more significant for funds that have equity exposure
- Smaller or new funds tend to have a higher turnover ratio
- Funds with a Value investing objective have a low turnover ratio compared to a fund with Growth investing objective
Most Equity schemes disclose their Portfolio Turnover Ratio as part of the Fund Fact Sheet every month, though, as per Securities and Exchange Board of India (SEBI) norms, they are required to disclose it twice a year only.
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