Portfolio turnover ratio indicates the frequency of changes in a fund. It is usually calculated for last one year. Calculation is done as below:
If a fund has sold ₹ 5000 crores stocks and bought ₹ 4000 crores stocks, and has average AUM of ₹ 8000 crores in last one year, lower value of sold and bought stocks will be divided by the average AUM and calculated as a percentage. So, in this case portfolio turnover ratio is 4000/8000 % = 50%.
Higher portfolio turnover ratio means fund has done frequent changes in the assets, which actually leads to more transaction costs considering the sale and purchase done.
Portfolio turnover ratio of 30 percent or lower is considered as a low portfolio turnover ratio. In between 30 to 80 percent is moderate to high, 80 percent or above is high. Please note that the portfolio turnover ratio should not be looked upon in isolation, but a comparison with other funds in the category gives a clear picture.
Is high portfolio turnover ratio bad because of more transactional costs?
To answer this question, let’s consider 2 funds, Fund A and Fund B.
Fund A is having very high portfolio turnover ratio continuously for the last 3 to 5 years or even more. The rolling returns generated by the fund is still in the bottom 50 percent in it’s category. It lags the benchmark return as well by a large margin. In this case, one should not be investing in the fund.
Fund B is having very high portfolio turnover ratio continuously for the last 3 to 5 years or even more. The rolling returns generated by the fund is in the top 25 percent in it’s category. It beats the benchmark by a large margin. This fund can be considered for investment.
So, the bottomline is that higher portfolio turnover ratio should generate higher returns. If not, it’s better to avoid such funds for investment.