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What Does Portfolio Turnover Ratio Mean?
The portfolio turnover ratio (PTR) means the rate at which the fund’s holdings have changed over a period of time. In simple words, it can be said that the portfolio turnover ratio tells you about the buying and selling frequency of a mutual fund portfolio.
PTR is basically calculated in percentage terms. It reveals a lot about the mutual fund and its fund manager. It is calculated for a period of 1 year.
So, basically, the portfolio turnover ratio represents the percentage to which the mutual funds turn over its stock and assets in the course of the past 1 year.
You can know many things about the mutual fund by looking at its PTR. In every monthly fact sheet of the mutual fund scheme, PTR is given for your analysis.
However, there is a very simple formula to calculate it. Portfolio turnover is calculated by dividing the lower of total securities sold or purchased by the average assets under management.
Let us understand by example. Suppose, during a year a fund purchased Rs. 600 crores of equity and sold Rs. 200 crores of equity, which makes its closing net assets as Rs. 1,400 crores (Rs. 1,000 crores + Rs. 600 crores – Rs. 200 crores).
So, the average asset under management is Rs. 1,200 crores [(Rs. 1,000 crores + Rs. 1,400 crores)/2]. Thus, portfolio turnover ratio is 16.67% (Rs. 200 crores / Rs. 1,200 crores).
This means that 16.67% of the assets of the portfolio were churned over the last 1 year.
Why Is PTR Important?
The portfolio turnover ratio gives clues about the management of the assets of the fund. It reflects which strategy the fund manager is using to earn returns.
A low turnover ratio reflects that the fund follows a buy and hold strategy. It can further be analyzed that the fund manager is confident about the chosen stocks purchases.
As a result, such funds will have a low expense ratio owing to the low transaction costs. A low turnover ratio may also represent that the fund belongs to a particular category of the mutual fund. It is seen that more value-generating fund tends to have a low turnover ratio.
Even in index funds, the fund manager matches the holdings of the fund with that of the underlying index. Consequently, there’s not much trading activity resulting in a low portfolio turnover ratio.
On the other hand, a high turnover ratio shows aggressive trading activities.
High turnover leads to high transaction costs and thus high expense ratio of the fund. Further, a high growth mutual fund and funds with aggressive strategies have a high turnover ratio.
Even, the market conditions affect the turnover of the mutual fund. A high volatile market causes the fund manager to stick to the ongoing portfolio, so a low turnover ratio.
Whereas, a rallying market encourages the fund manager to indulge in frequent trading, resulting in a high turnover ratio.
How To Analyse A Fund Based On PTR?
After knowing what portfolio turnover ratio means and what the low/high ratio depicts, it’s important to understand how to analyze a fund based on its portfolio turnover ratio.
When a fund manager is trading securities of the portfolio, the transaction costs increase. An increase in transaction costs automatically increases the expenses of the fund.
A high churning of the portfolio will thus lead to high expenses. Now, if this churning increases the return of the portfolio and if such returns compensate such increased expenses then the high portfolio ratio can be justified.
On the contrary, if the increase in expenses and high transaction costs are not reflected in the returns of the fund, then it might be a concern.
There can be a number of reasons for nonperformance of the fund. Chances can be that the fund manager is not aware of the market environment and using the trial method to reach an ideal stock portfolio.
At such times, you will end up paying higher management costs with low returns.
Thus, for full and accurate analysis of the fund, you have to consider certain other ratios as well, along with the portfolio turnover ratio. Apart from this, you should know your investment objectives and risk profile. All this knowledge together will help you make the right investment decision.
Disclaimer: The views expressed in this post are that of the author and not those of Groww