The term Portfolio Turnover Ratio is an important aspect of analysing the performance of a mutual fund. It gives an idea of the trading activity of any mutual fund in a given period of time. In addition, it reveals the fund manager’s performance. But before establishing the importance of Portfolio Turnover Ratio in mutual funds, investors must learn about its different aspects.
Portfolio Turnover Ratio is the frequency in which the assets held under a fund has changed over the years. In simpler words, PTR provides a measurement on how many times the fund managers bought or sold the assets under a fund over a period of time. PTR is often determined by the market conditions and fund management style.
The portfolio turnover ratio can be calculated using a very simple method. You can take the minimum of either bought stock or sold stocks under a fund and divide them by the average Assets Under Management (AUM). The number you get is the Portfolio Turnover Ratio of that particular fund. The stocks and the AUM have to be taken from the same time horizon. The time horizon can be monthly or yearly. The PTR is always stated in percentage.
Suppose an equity fund purchased stocks worth Rs. 375 crore and sold stocks worth Rs. 450 crore. The average AUM of the fund is Rs.1500 crore. In this case, the Portfolio turnover ratio of the fund is 25%, which means one-fourth of the stocks were traded. This can be calculated using the following Portfolio Turnover Ratio formula:
|Minimum stocks bought or sold (Rs.375 crore)) / Average AUM (Rs.1500 crore) = Portfolio Turnover Ratio (25%)|
Portfolio Turnover ratio understanding in the fund’s activities. The high and low PTR can indicate the below-mentioned factors:
The fund management style, market condition and other indications of Low Portfolio Ratio is the exact opposite of High Portfolio Turnover.
The more a fund manager purchases or sells stocks, the more expensive the expense ratio becomes. Higher tax is a result of capital gains distributions. These taxes travel from the fund managers’ trading costs to the investor’s returns. So, a fund with a High Portfolio Ratio will generate higher taxes than a fund with Low Portfolio Turnover Ratio.
The Portfolio Turnover Ratio evaluates mutual funds by measuring the risk factors. By comparing the PTR of two or more mutual funds, an investor can find the most suitable options. The aggressive strategy of the fund managers leads to high expense ratio; however, the high expense ratio is adjusted by a high return rate. As said earlier, the fund managers can keep purchasing and selling the stock just to meet the ideal return rate. But the required high trade fees in this scenario, affect the investor’s returns. When a high return rate adjusts the higher expense ratio, the investors keep gaining capital. But, the investors are forced to face loss in the capital when the higher expense ratio does not come with high returns. The investors thus end up paying higher fund management costs without getting proper returns.
Investors tend to avoid investing in funds with high Portfolio Turnover Ratio due to the high expense ratio. But they miss out on the chance to get higher returns that could have been achieved by investing in superior funds with consistent performance.
Besides, following are a few other things that should be kept in mind:
The investors must understand all the influencing factors before investing in getting the required returns. Many other ratios other than PTR should be used while analysing the funds. More importantly, each investor has their own objective and risk profile. The PTR can help the investor to choose the correct investment option by balancing their risk appetite with the fund’s risk level.