What is Portfolio Turnover Ratio?

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  • By BYSOS Expert
  • July 27, 2021

Portfolio Turnover Ratio (PTR) reveals the entire story about the buying and selling activity happening within a fund.

Portfolio Turnover Ratio indicates the frequency with which the fund’s holdings have changed over the past one year. In other words, you may perceive it as turning over of asset under management. It is expressed in percentage terms. PTR provides insights about a lot of things. It gives an idea about the fund manager’s overall investment strategy.

Formula for the Portfolio Turnover Ratio

The formula for the portfolio turnover ratio is as follows:

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.

What is the importance of Portfolio Turnover Ratio?

Portfolio turnover ratio can provide clues about the manner of fund management. It reveals which kind of strategy the fund manager is using to generate returns on investment. A low turnover ratio indicates a buy and hold strategy. It means that the fund manager is confident about his stock purchases. Moreover, he plans to hold them for the entire investment horizon of the fund. Automatically, such a fund will have a low expense ratio owing to low transaction costs. Low portfolio turnover ratio might also be due to the fund category.

In passive funds like index funds, the fund manager merely matches the funds’ holdings with that of underlying index. Consequently, there’s not much trading activity resulting in low a portfolio turnover ratio. Funds having a high portfolio turnover ratio entail aggressive trading activity. The fund manager keeps buying and selling the securities to take advantage of the situation.

The level of portfolio turnover ratio also depends on market conditions. A highly volatile market causes the fund manager to sit tight thereby keeping turnover ratio at low levels. On the contrary, a rallying market encourages fund manager to indulge in frequent trading; thereby increasing the portfolio turnover ratio.

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.

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