What is Turnover Ratio in Mutual Funds? Why is it important?

A look at what is a turnover ratio in mutual funds

Turnover Ratio Mutual Funds

Turnover ratios are widely used in accounting to measure performance in organisations. In mutual funds too, the same term has a similar meaning in principle. The turnover ratio depicts the changes in the fund scheme. Changes in the fund portfolio affect the cost of maintaining the fund as well. Firstly, let us understand what is the turnover ratio in mutual funds. 

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What is Turnover Ratio?

A mutual fund scheme invests the money collected from investors in various assets, be it equities or debt instruments. The fund manager monitors the performance of these assets. If a churning in the portfolio is required, the fund manager does so to keep the returns optimised. This churning is essentially the buying and selling of the assets under management (AUM). Changes in the AUM structure are mathematically depicted by the turnover ratio.

How is it Turnover Ratio Calculated?

The turnover ratio is calculated by dividing the minimum of stocks bought or sold by the month-end AUM. If the turnover ratio is 100% it means that the portfolio has changed completely in the past year. It also means that the average holding period of the portfolio was one year. If the turnover ratio is 200% it means that the average holding period is six months. 

The calculation method may differ among fund houses. Some of them measure the turnover ratio of the total portfolio, i.e. cash, debt, equity or other assets. Others consider the turnover ratio of the equity portfolio only. Some funds may disclose both ratios.

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What does Turnover Ratio indicate?

The turnover ratio indicates a fund manager’s investment strategy. A low turnover ratio indicates a buy-and-hold strategy, while a high ratio means that the fund manager actively churns the portfolio to profit from booking gains. 

What is the impact of Turnover Ratio on cost?

A higher turnover ratio affects the returns of a fund. A high turnover means higher churning, which means more payments in brokerage and securities transaction tax (STT). These costs are then passed on to the investors. Brokerage costs stand at about 8-10 paisa per 100, these days. STT on equity share is 0.1% of the share value in case of delivery and 0.025% for intraday.

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The turnover ratio must not be seen in isolation. A high portfolio turnover ratio shouldn’t be a turn-off for potential investors. If the fund manager is achieving higher returns through active churning, it is a welcome strategy for you. Therefore, always review the turnover ratio in conjunction with returns and other parameters.




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