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What is the portfolio turnover ratio?

The portfolio turnover ratio is a measure of the frequency at which assets within a portfolio are bought and sold over a specific time frame, usually a year. It indicates the percentage of the portfolio's holdings replaced or turned over during the period. Essentially, it measures the trading activity within the portfolio. A higher turnover ratio implies more frequent buying and selling, while a lower turnover ratio suggests less activity

How to calculate portfolio turnover ratio?

The portfolio turnover ratio can be calculated using the following formula:

Portfolio Turnover Ratio = (Total Value of Securities Bought or Sold During the Period /

Average Value of Portfolio Assets During the Period) × 100

This ratio can be calculated for a specific portfolio, fund, or investment strategy. It's important to note that the turnover ratio is usually reported on an annual basis.

What does the high portfolio turnover ratio indicate?

A high portfolio turnover ratio typically indicates that the fund manager is actively buying and selling securities. This level of activity can result from various reasons, such as attempting to capitalise on short-term market movements, implementing a trading strategy, or adjusting the portfolio's composition in response to changing market conditions or investment objectives.

While high turnover can potentially lead to higher returns if executed successfully, it also comes with certain drawbacks. Frequent trading can increase transaction costs, such as brokerage fees and taxes, which can erode overall returns. Additionally, high turnover may indicate a higher level of risk, as it suggests that the portfolio is more prone to market fluctuations and volatility.

What does the low portfolio turnover ratio indicate?

On the other hand, a low portfolio turnover ratio suggests that the portfolio manager is holding onto investments for longer periods without actively buying and selling. This could be indicative of a more passive investment approach, where the focus is on long-term growth or income generation rather than short-term trading strategies.

A low turnover ratio may be preferred by investors seeking relative stability and lower transaction costs. It indicates a more patient and disciplined investment strategy, where the fund manager is confident in the long-term prospects of the chosen investments.

However, it's important to note that a low turnover ratio doesn't necessarily guarantee a better return potential, as that depends on the performance of the underlying assets.

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