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Should frequent portfolio churning by the fund manager worry you?

Portfolio Turnover Ratio is calculated as a percentage of sale or purchases of securities (whichever is lesser) made by a mutual fund scheme during a particular period (usually a year) divided by its average assets.

Equity fund managers often advise mutual fund investors on television to take a long-term view. Do they practice what they are preaching?

Portfolio Turnover Ratio (PTR) is one such statistic that will let you find it out. It highlights the extent to which the portfolio is churned by a mutual fund scheme in a year.

Nitty-gritty

PTR is calculated as a percentage of sale or purchases of securities (whichever is lesser) made by a mutual fund scheme during a particular period (usually a year) divided by its average assets. For instance, if Rs 300 crore worth of stocks were purchased/sold in a year, while average assets were Rs 500 crore, PTR for that scheme is 60 percent (300/500 multiplied by 100). It indicates that, on an average, 60 percent of the equity portfolio was churned during the year.

What does it mean?

A 100 percent portfolio turnover, however, doesn’t necessarily mean that the whole portfolio was replaced in a year. Usually, fund managers have a long-term orientation on the core portfolio, while trading frequently on the rest to capitalise on emerging opportunities. So, a 100 percent PTR can also mean that a part of the portfolio was churned many times over.

PTR can be higher for many reasons. 

Market condition

Volatile equity markets throws up opportunities resulting in fund managers changing their portfolio. Similarly, changing macroeconomic conditions and government initiatives can make certain sectors more lucrative than others. Fund managers tweak the portfolio to make the most of it. 

Fund mandate

Moreover, PTR can change based on the type of equity fund. Growth-oriented funds, in general, have higher PTR than value and index funds. Index funds trade only when there is a change in the composition of the index and value funds by dint of their philosophy tend to hold on to undervalued stocks till it reaches its targeted value. Growth funds, in contrast, are on the constant look out for stocks and sectors that will be out-performers, resulting in a lot of buying and selling being made. Similarly, asset-allocation funds could have high PTR due to its dynamic fund management.

As per latest data, large & mid cap (58%) and multi cap (47%) category had the highest PTR (median) among equity funds, while small cap had among the lowest (21%). 

House Philosophy

Moreover, the investment philosophy of the fund house influences the PTR statistics. For instance, players  have a high PTR for its equity funds (major categories) as compared to others, as per latest available data. Perhaps their fund managers want to capitalise on short-term market opportunities by way of trading. Some invest in derivatives to capitalise on mis-pricing opportunities between cash and futures market. Then there were others who were found to have very low portfolio turnover ratios for their equity funds.

Churning and Returns

Just because a fund is churning a portfolio more frequently doesn’t mean its returns are going to be better. A fund manager needs to resort to prudent stock picking to stay ahead of the curve. 

Having said that, it has also been seen that stable portfolios have often resulted in market out-performance than otherwise. A consistently high portfolio turnover only indicates the fund manager is chasing momentum stocks which are a riskier bet.

Moreover, PTR is not a litmus test to figure out if your fund is doing well or not. At best it is a complementary decision-making tool which you should use in addition to checking its consistency of performance, its risk-adjusted return measure, expense ratios and other factors. 

No litmus test

One should not read too much into a single PTR statistic. Rather investors should look at long-term trends. 

Moreover, PTR is not a litmus test to figure out if your fund is doing well or not. At best it is a complementary decision-making tool which you should use in addition to checking its consistency of performance, its risk-adjusted return measure, expense ratios and other factors. 

Takeaway

Fund managers or day traders in disguise? PTR will let you find that out. Use PTR as an additional tool to shortlist equity funds. 

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