How to calculate portfolio turnover ratio?

The portfolio turnover ratio of a mutual fund is an important parameter that provides insight into the trading patterns and strategies employed by the fund manager. It indicates the frequency with which the underlying holdings in a mutual fund scheme are replaced or reallocated by the manager over a given period of time. A higher turnover ratio tends to result in higher transaction costs for the fund, which are ultimately borne by the investors.

Read on to understand more about turnover ratio and see how to calculate portfolio turnover ratio.

• Table of contents

1. How to calculate portfolio turnover ratio in mutual fund?
2. Interpreting the ratio
3. Factors that can cause a consistently rising turnover ratio
4. FAQ

How to calculate portfolio turnover ratio in mutual fund?

The turnover ratio of a mutual fund is calculated based on the lesser of total purchases or total sales of securities made by the scheme over a period, usually one year. The first step is to determine this ‘lesser amount’, which represents the value of capital gains, whether short-term or long-term, generated through trading activity.

For example, if the total purchase of securities by a mutual fund scheme during the year was Rs.1000 crore and total sales amounted to Rs.900 crore, the lower or lesser value would be Rs.900 crore. This step helps account for instances where the fund manager replaces only a portion of holdings rather than the entire portfolio at one go.

The next input required is the Average Monthly Net Assets (AMNA) of the scheme, which is used as the denominator to annualize the ratio. AMNA is calculated by taking the daily net assets of the fund over the period and computing their monthly average. This helps account for any significant net subscriptions or redemptions over the year.

The formula to calculate the portfolio turnover ratio is:

Lesser of Total Purchases or Total Sales during the Year ÷ Average Monthly Net Assets

Using the previous example, if the AMNA of the fund was Rs.1000 crore:

Rs.900 crore ÷ Rs.1000 crore = 0.9

To annualize this ratio, it is multiplied by 100 to report it as a percentage depicting the rate at which the portfolio was replaced in that one year.

In this case, the portfolio turnover ratio would be: 0.9 x 100 = 90%

Interpreting the ratio

An ideal portfolio turnover is difficult to specify as it varies across categories and investment styles. But some general guidelines hold true.

• Index mutual funds tend to mimic the index composition and hence demonstrate extremely low (<5%) turnover.
• Actively managed multicap funds may range between 20-40% depending on market conditions and opportunities.
• On the other hand, certain categories like arbitrage and some debt funds have intrinsic higher portfolio churn rates. For example, liquid and ultra-short term debt categories may have turnover in the range of 100-300% annually to potentially optimize short-term opportunities.

Factors that can cause a consistently rising turnover ratio

• Change in strategy: One of the major reasons could be a change in the underlying investment strategy and style adopted by the fund manager. A transition from an earlier buy-and-hold approach to a more actively traded approach (focused on frequent rebalancing and profit booking) would naturally increase the churn in the portfolio.
• Market volatility: Similarly, turbulent market phases with high volatility often prompt fund managers to trade stocks more regularly in order to capitalize on emerging opportunities or quickly adjust portfolio weightages based on changing market dynamics.
• Index composition: The composition of the benchmark index that an index fund tracks can also experience periodic revisions, necessitating higher trading activity by the fund to align its portfolio. For example, in the case of actively managed large-cap funds attempting to stay close to their benchmarks, increased buying and selling of constituents may be needed during such rejigs.
• Performance-oriented: Major restructurings of the portfolio aimed at improving fund performance can temporarily spike the turnover as older stocks are replaced extensively with new holdings.
• Large inflows or outflows into the fund: These can also force the manager to undertake proportionally higher volumes of purchases or liquidations of existing holdings. This impacts portfolio churn.

Ongoing monitoring

It is advisable to track the portfolio turnover of chosen schemes on a regular basis, ideally every 6-12 months. A consistently rising ratio may require further investigation to understand underlying causes like change in investment style, trading losses, or excessive churning impacting returns over long periods of holding.

Sharp increases also warrant monitoring fund manager changes or market volatility impacts. Therefore, periodic comparative analysis of this important parameter provides valuable insight regarding sustainability, temptation for window dressing, and behavior of the fund house over different market environments.

Conclusion

Portfolio turnover ratio is a key metric in analysing a mutual fund scheme. It represents the frequency with which the underlying holdings are replaced or reallocated in a given timeframe. Understanding how the portfolio turnover ratio is calculated can enable investors to gauge the trading pattern adopted by fund managers. This will help them to make an informed evaluation of the transaction costs, volatility and durability of a given scheme’s returns delivery over the long run.

FAQs:

What does a high portfolio turnover ratio signify for a mutual fund?
A high portfolio turnover ratio suggests that the fund frequently buys and sells assets within the portfolio. This can result in higher transaction costs for investors.

How can I compare the portfolio turnover ratios of different mutual funds?
To compare portfolio turnover ratios, consider your investment strategy. If you prefer a buy-and-hold approach, look for funds with lower turnover.

Does a low portfolio turnover ratio always correlate with relatively better returns?
Not necessarily. While a low portfolio turnover ratio can be tax-efficient and cost-effective, it doesn't guarantee relatively better returns. The performance of a mutual fund depends on various factors, including the manager's strategy and market conditions.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
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