IS YOUR mutual fund manager churning the portfolio too much? Investors can use a scheme's portfolio turnover rate to find out what percentage of a mutual fund has been replaced with other holdings in a given year. All things being equal, investors favour low turnover funds as a high turnover equates to higher brokerage transaction fees, which reduce the fund and consequently your returns, experts told Financial Chronicle.
A fund with a high turnover rate will incur more transaction costs than a fund with a lower rate.
Unless a superior stock selection occurs, a high portfolio turnover does not pass on any benefit that can offset the added transaction costs. A stock index fund (such as Sensex or Nifty fund) will have a low turnover rate, but actively managed stock funds such as diversified or thematic schemes will have high turnover because active trading is an inherent quality of stock investments. But the trick is not go overboard with trading because more frequent the trading, higher is the fund's expenses.
Portfolio turnover data can be found in the fact sheets of specific funds and also available on websites such as mutualfundsindia.
If a fund has a 100 per cent turnover rate, the fund replaces all of its holdings over a 12-month period.
An aggressive small-cap growth fund will generally experience higher turnover than a large-cap value stock fund. Mutual fund portfolio turnover is calculated by taking the value of all transactions (buying, selling) and the fund's total holdings. The measurement is usually reported for a 12month time period by most Indian schemes.
Financial planners also consider the portfolio turnover data before pitching funds to clients. The rate is usually 100-200 per cent and for aggressive funds, it could be even be 300 per cent. A fund with a small corpus but extremely high turnover rate is not a good thing.
The turnover rate in your mutual fund is really just a measure of the frequency of transactions in your funds. There is no given formula to ensure if it works or does not work. In the case of some mutual fund houses, such as Reliance Capital Asset Management, the equity fund managers are known to churn their schemes portfolios often in order to exploit short-term profit potential in momentum stocks. Whether the desired profit is achieved or not, the fund manager will tend to exit such stocks within a few weeks.
A new fund offering will automatically have a high turnover. Like all tools, it's an important metric only if you use it carefully. Funds having value or growth style of investment will also show a different portfolio turnover ratio because value funds are biased towards buy-and hold. Growth funds are constantly looking for sectors and stocks that are the next leaders generally implying more trading.
