Portfolio Turnover Ratio

The rate of which assets in a fund are bought and sold by the portfolio managers

What is the Portfolio Turnover Ratio?

The portfolio turnover ratio is the rate of which assets in a fund are bought and sold by the portfolio managers. In other words, the portfolio turnover ratio refers to the percentage change of the assets in a fund over a one-year period.

 

Portfolio Turnover Ratio

 

Formula for the Portfolio Turnover Ratio

The formula for the portfolio turnover ratio is as follows:

 

Portfolio Turnover Ratio

 

Where:

  • Minimum of securities bought or sold refers to the total dollar amount of new securities purchased or the total amount of securities sold (whichever is less) over a one-year period.
  • Average net assets refer to the monthly average dollar amount of net assets in the fund.

 

Interpreting the Portfolio Turnover Ratio

For example, a 5% portfolio turnover ratio suggests that 5% of the portfolio holdings changed over a one-year time period. A ratio of 100% or greater indicates that all the securities in the fund were either sold or replaced with other holdings over a one-year period.

The portfolio turnover ratio is important to consider before purchasing a mutual fund or a similar financial instrument, as it affects the investment return of the fund. Generally speaking, a low turnover ratio is desirable over a high turnover ratio. The rationale is that there are transaction costs involved with making trades (buying and selling securities).

In addition, funds with a higher portfolio turnover ratio are more likely to incur higher capital gains taxes. All else equal, a portfolio with a higher turnover ratio will be incurring more expenses than a fund with a lower turnover ratio.

However, it is not to say that a high portfolio turnover ratio is not desirable. A high turnover ratio is justified if the fund manager is able to generate comparatively higher returns (on a risk-adjusted basis) than a similar-style fund with a low turnover ratio. If the ratio is high, and the fund is underperforming its benchmark on a risk-adjusted basis, investors should be looking at alternative funds.

 

Portfolio Turnover Ratio and Investment Strategies

The portfolio turnover ratio provides insight into how a fund manager manages its fund.

Generally speaking, a portfolio turnover ratio is considered low when the ratio is 30% or lower. When the turnover ratio is low, it indicates that the fund manager is following a buy-and-hold investment strategy. Funds with a low turnover ratio are called passively managed funds.

On the other hand, funds with a high turnover ratio indicate a considerable amount of buying and selling of securities (a fast-paced investment strategy). Funds with a high turnover ratio are called actively managed funds.

In addition, it is useful to track the ratio on a trended basis. It is done to determine if the fund manager’s investment strategy has changed. For example, a portfolio turnover ratio change from 20% to 80% over a three-year period would indicate that the fund manager has dramatically changed investment strategies.

 

Practical Examples

 

Example 1: Calculating the Portfolio Turnover Ratio

A fund purchased and sold $10 million and $8 million of securities, respectively, over a one-year time period. Over the one-year period, the fund held average net assets of $50 million. What is the fund’s portfolio turnover ratio over the past year?

Solution: The portfolio turnover ratio for the fund is calculated as ($8M / $50M) x 100 = 16%.

 

Example 2: Inferring the Investment Strategy Through the Portfolio Turnover Ratio

A fund prefers an investment strategy of capitalizing on changing market conditions. The fund’s portfolio turnover ratio was reported to be 95%. What would it imply about the fund’s investment strategy?

Solution: Due to the fund’s portfolio turnover ratio of 95%, it would imply that the fund follows a fast-paced and aggressive investment strategy.

 

Additional Resources

CFI is the official provider of the Certified Banking & Credit Analyst (CBCA)™ certification program, designed to transform anyone into a world-class financial analyst.

In order to help you become a world-class financial analyst and advance your career to your fullest potential, the additional resources will be very helpful:

  • Public Securities
  • Risk-Adjusted Return Ratios
  • Return on Net Assets (RONA)
  • Investing: A Beginner’s Guide

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