Mutual Fund Investments can offer investors very promising returns over a long-term period. When considering which Mutual Funds to invest in, it is important to consider the turnover ratio of a fund. We are going to tell you why.
When investors invest in Mutual Funds they usually keep a watch on how the Mutual Fund manager realigns and revises the investment portfolio annually. This can effectively be analysed through studying the portfolio turnover ratio.
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Turnover ratio? What’s that?
The turnover ratio is a measure of how a Mutual Fund’s portfolio holdings evolve and change over a period of time. Let us learn how we can use the turnover ratio to better understand the performance of Mutual Funds.
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How is turnover ratio calculated?
You can calculate a portfolio’s turnover ratio with this formula.
The total number of new securities bought or the number of securities sold (whichever is lower)
Total Net Asset Value of the Mutual Fund
Significance of turnover ratio
When you think about the significance of turnover ratio, remember this: If the rate of changes in the fund’s portfolio is higher, the transaction cost will be higher.
BB Tip: Mutual Funds that are managed rather aggressively tend to have a higher portfolio turnover ratio compared to conservatively managed Mutual Funds.
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What does a low turnover ratio symbolise
According to analysts, low turnover ratios of 30-50% show that the Mutual Fund follows a buy and hold strategy.
On the flipside, if a Mutual Fund has a 100% turnover ratio, it means the fund portfolio has been completely realigned. This shows an investor that the fund has experienced high levels of buying and selling.
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Why you should be careful of funds with high turnover ratio
A high turnover ratio in Mutual Funds will add to the expense ratio of the fund because there will be higher transaction costs. This may impact the returns generated by the fund.
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What does a high turnover ratio mean?
Don’t sweat over a high turnover ratio. It may not always be bad. In a long-term bull market, a high turnover ratio may indicate that the fund manager has taken advantage of available investment opportunities.
In a sinking market, the Mutual Fund manager may want to buy and hold shares of certain companies to balance out the slump in the fund’s portfolio.
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How asset allocation affects turnover ratio
Those Mutual Funds that have a dynamic asset allocation, and buy and sell equities based on market conditions, will also usually have a higher portfolio turnover ratio.
If a Mutual Fund scheme records a high turnover ratio, this could mean that the fund relies on short-term trading, rather than a ‘buy and hold’ investment strategy.
It may be a good idea not to consider only the turnover ratio of a Mutual Fund when deciding on investing in certain Mutual Funds. It is recommended that investors compare the portfolio turnover of Mutual Funds within a certain category of funds.
In case a Mutual Fund has shown a high turnover ratio and has also recorded consistently high returns, it means the turnover has had a positive impact on the performance of the fund.
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Now that you have wizened up about turnover ratio, you can analyse your own Mutual Fund investments much better.