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What Is Mutual Fund Portfolio Turnover Ratio

Looking to understand portfolio turnover ratio in mutual funds? Read here to know about turnover ratio, how to calculate, interpret & implement to make your investment.

Mutual fund investments are leading investment vehicles today, with the majority of large and small investors opting for mutual funds as a part of their financial portfolios. In case you are a potential mutual fund investor, you may want to familiarise yourself with terms and aspects that relate to mutual funds, like, for instance, the portfolio turnover ratio in mutual fund investment. 

As you will see, this has some bearing on the way that capital is allocated to a mutual fund and managed further. Mutual fund managers, in the process of optimising returns from mutual fund investments for clients, regularly rebalance funds. Thus, they purchase and sell assets in order to align with the goals of investors and aim for maximal returns. The rate at which the assets in any given mutual fund are purchased and sold by fund managers is known as the portfolio turnover ratio in mutual fund investments. Simply put, the ratio represents a percentage change regarding the assets in any mutual fund over a period of a year. 

How to Calculate the Portfolio Turnover Ratio - The Formula

To calculate the ratio, the following formula is used: 

The Portfolio Turnover Ratio = (the Minimum of Securities Purchased or Sold/the Net Average Assets) x 100

Where: 

  • The Minimum of Securities Purchased or Sold represents the total rupee amount of fresh/new securities bought or the total securities which have been sold (whatever is less) over a period of a year. 
  • Net Average Assets represent the average monthly rupee amount comprising net assets in the whole fund. 

How to Interpret the Portfolio Turnover Ratio Formula 

Just knowing how to calculate the portfolio turnover ratio in mutual fund investments isn’t enough. To have a better awareness of its implications, you should know how to interpret results. For instance, let's say that you get a result of the portfolio turnover ratio of 5% in any fund. This suggests that 5% of the holdings in the portfolio have changed over a period of a year. If you get a ratio that equals 100% or more, then this indicates that all the securities that the fund is composed of were either replaced or sold with other holdings in the period of a year. 

Why is the portfolio turnover ratio important? Before you sign up for a mutual fund or any other fund that is similar, you must know about the mutual fund turnover rate. This affects the return on investment of the fund in question. Generally, a turnover ratio that is low is favourable than one which is high. The rationale behind this is that there are transaction costs associated with trading (the purchase and sale of securities). Additionally, mutual funds with increased portfolio turnover ratios tend to incur greater taxes in terms of capital gains. A portfolio that has a higher turnover ratio incurs greater expenses than any fund with a low ratio, other factors being equal. 

Nonetheless, this doesn’t mean that higher ratios are not preferred. High turnover ratios have some justification if fund managers have the ability to generate relatively higher returns than a fund of a similar nature with low ratios. If ratios are high and funds are not performing up to the mark (on a basis of adjusted risk), investors should consider alternatives. 

What should be the investment decision based on the portfolio turnover ratio?

Insights into the way fund managers are managing mutual funds are given by the fund turnover rate. Essentially, a ratio of the turnover of the fund is low when it is equal to 30% or even lower than this. This indicates that the fund manager is employing a strategy of buy-and-hold. Mutual funds that have a low turnover rate are usually passively managed funds. Depending on what kind of investor you are, you can go for a fund based on this. 

Comparatively, those funds that boast of a high turnover ratio imply that a substantial amount of purchasing and selling securities is taking place. This investment strategy is dynamic and funds that employ this are actively managed funds. Based on such dynamism, and a potential for risk of investment, you may make decisions to invest in such funds. 

Tax Implications & Expense Ratio Relating to the Portfolio Turnover Ratio 

A portfolio turnover ratio in mutual fund investment which is high means that there are increased levels of costs associated with funds. These may translate to expense ratios (the costs of management and administration of the funds) being significantly elevated. This not only reduces the performance of the fund, but makes it expensive for investors to invest in such funds. High rates of turnover also have negative consequences where taxation is concerned. These funds are more likely to attract capital gains taxation. This, of course, is spread out and has to be borne by investors. 

How to Calculate the Portfolio Turnover Ratio - Solved Example (200 - 250 words)

Some practical examples will help you to grasp the exact nature of how the turnover ratio of mutual fund investment works: 

Example #1 - Computation of the Turnover Ratio 

Let us say that a fund bought and sold Rs. 10 crore and Rs. 8 crore worth of securities. This was over a time period of a year. Within the period of a year, the fund was holding net average assets of Rs. 50 crore. With these values, what is the portfolio turnover of this fund for the past year?

The Solution: (Rs. 8 crore/Rs. 50 crore) x 100 = 16%

Example #2 - Making an Inference of the Investment Strategy via the Portfolio Turnover Ratio

A specific fund favours a specific kind of investment strategy in which the capitalisation based on certain market changes occurs. This particular fund’s turnover ratio was at 95%. What would this imply regarding the investment strategy of the fund in question?

The Solution: As the portfolio turnover ratio in mutual fund investment for this fund is 95%, the implication is that the fund practises a dynamic and aggressive strategy where investment is concerned. 

FAQs

  1. How does an individual interpret the Portfolio Turnover Ratio?

In terms of a percentage, the portfolio turnover ratio of 5% of a given fund indicates that 5% of the holdings of that particular portfolio changed over a period of a year. 

  1. What is said to be a good portfolio turnover ratio?

A good portfolio turnover ratio should be in the region of 20% - 30% for index funds.

  1. Is turnover important to investors of mutual funds?

The turnover ratio is crucial when assessing ETFs or mutual funds to invest in. The ratio tells you a lot about the way a fund and a fund manager conducts operations. 

  1. If you see a high portfolio turnover ratio in mutual fund investment, what does it mean?

Generally, a higher rate of turnover is a reflection of a mutual fund or ETF having bought and sold all its positions in the past year. 

  1. How does AUM influence the portfolio turnover?

The AUM is used in the formula to evaluate the portfolio turnover ratio. The AUM or net average assets of the past year are taken into consideration while making calculations of the ratio. 

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