Introduction
Portfolio turnover refers to a measure of the frequency of change in assets of a fund. The turnover measures the frequency of purchase and sale by portfolio managers.
The managers calculate the portfolio turnover by aggregating either the cost of new securities or the sale value of securities sold over a period. The value taken is the lower of the two, further divided by the net asset value. The period is generally 12 months.
Understanding Portfolio Turnover
Portfolio turnover measures the speed in which securities are bought or sold by fund managers at a particular time. It is critical to know the rate at which the buying and selling happen to decide whether to invest in the fund or not. Funds having a higher rate are likely to have higher fees collected as a percentage of the turnover.
From a tax cost perspective, funds having a high rate generally have taxable capital gains. The fund, however, does not pay the taxes because it enjoys a pass-through status.
The taxes are passed to the investors for payment at the time of filing of their income tax return. In comparison to passive funds, growth funds are active and have high investor participation and turnover.
Any potential investor considers the turnover as a measure for deciding whether to invest in a fund or not. A high turnover means a high cost for the investor and lower net income. However, there may be instances in which a high rate of turnover fetches high returns which in turn increases the profits of the investor.
Fund investors are conscious of their transaction costs and net returns. It is important for the investors to note that fund houses do not include brokerage in their operational expenses, thus resulting in incremental costs reducing the return on investment. An investor should account for all costs and taxes to arrive at their return.
Conclusion
Certain investors may avoid high turnover funds due to their higher costs. However, certain investors may choose such funds which also offer a high return on investment due to a higher churning of portfolios.
There are instances where fund managers have exceeded the returns on index funds. Hence, portfolio turnover analysis is a tool but not a decision-maker in investing.
