Fund managers go in for the big churn

“Invest for the long term, don’t worry about short-term fluctuations,” is fund managers’ favourite advice to mutual fund (MF) investors who panic at the first signs of market downturn. But most fund managers do not practice what they preach. In other words you may have invested in an equity fund with a three-year investment horizon, only to find that your fund manager has a six-nine month view on the stocks in the portfolio.

According to ETIG estimates, MF manager are rapidly churning portfolios. On an average, they buy stocks and sell it within nine months. In technical terms, such churn is referred to as portfolio turnover ratio. Across the industry, the average turnover ratio of portfolios is around 135%.

What could be the reasons for such high-level portfolio churns?

“Changes in portfolios happen primarily due to target prices being met, relative valuations and change in fundamentals,” says Sivasubramanian KN, portfolio manager-equity, Franklin Templeton.

But that is not always the reason, say market watchers. Often fund managers churn portfolios in order to generate quick returns. And investors are partly to blame for this trend as many of them actively churn their own MF portfolios in favour of better performing schemes. Also a 100% portfolio turnover might not necessarily mean complete change of fund portfolio. It is also possible that fund managers keep a core portfolio that is intended for the long-haul, while he rapidly changes his trading portfolio to make quick bucks from market opportunities.

There is some relief for investors though; portfolio turnover ratios have been falling over the years. For instance, in the first four months of 2007, it was 110%. In 2006, it was higher at 124%. In 2005, it was even higher at 132%. 2004 saw one of the highest portfolio turnover of 160%. One reason for this falling trend could be ‘higher mid-cap’ exposure of equity funds that is yet to see a rally. It is believed that many equity funds with exposure to mid-cap stocks are holding on in the hope of a rally in the near future. In the past one year, mid-cap indices have underperformed large-cap indices.

As per latest portfolio disclosures, many top equity diversified funds had 100% plus portfolio turnover ratios. Reliance Equity had a portfolio turnover of 154%, ICICI Pru Growth —236%, HDFC Equity —158% and Franklin Bluechip — 93%. Sector funds resorted to lesser churn. For instance, for Franklin Pharma it was 32%, Reliance Pharma — 26% and ICICI Pru FMCG — 16%. These ratios were for the half-year ended March 2007.

Equity Portfolio turnover for the MF industry was calculated by taking the lower of 12-month gross purchase or sale divided by the trailing annual equity assets. While the gross purchase and sale figures of MF from capital market was taken from Sebi, equity-based asset figures were sourced from Association of Mutual Funds of India.