Learn with ETMarkets: Why turnover ratio is important

Investors are keen to know how many times a fund manager changes his portfolio in a year. This can be measured by using the portfolio turnover ratio. Turnover ratio is a measure of how a fund's portfolio holdings change in a given year. This ratio indicates how much a fund is trading. Understanding turnover ratio helps in gaining insights into a fund's performance.

1. How is it calculated?
Portfolio turno ver is calculated by taking either the total amount of new securities purchased or the amount of securities sold -whichever is less -over a particular peri od, divided by the total net asset value ( NAV) of the fund. This is usually done for a 12-month time period.

2. What is its significance?
Higher the churn in the portfolio, more is the transaction cost.

Aggressively managed funds will generally have higher portfolio turnover rates than conservative funds.

Analysts say a low turnover figure (30% to 50%) indicates that the fund adopts a buy and a hold strategy . On the other hand, if you no tice a fund having a turnover ratio of over 100%, it indicates that the portfolio has been churned over entirely .

This indicates a very high buying and selling activity in the fund.

Such high turnover will add to the expenses of the fund by means of transaction costs and may affect returns.

3. What does a high turnover ratio indicate?
A high turnover ratio may not be necessarily bad. In a long bull market, one may see a high turnover ratio as the fund manager makes the most of available opportunities, while in a falling market, the fund manager prefers to buy and hold select companies to stem the fall in portfolio.Funds that have a dynamic asset allocation, which buys and sells based on valuations of the market, also tend to have a higher portfolio turnover.

If the scheme in consideration, due to its underlying strategy , has a high turnover ratio, it could mean the fund relies on short-term trades compared to a buy and hold strategy . Analysts suggest not using the portfolio turnover ratio in isolation. They suggest comparing portfolio turnover of funds within the same category . If the fund has a high turnover ratio and has delivered higher returns consistently , it means churn has helped the fund.