One of the important considerations that are essential for individual investors in mutual funds is the manner in which the portfolio is being handled. This will give an idea about the manner in which things are moving and also the exact impact that will be felt when the portfolio is being handled in a specific manner. This is something that needs to be considered and hence it will require some attention from the individual investor. One of the ways in which the portfolio behavior is considered is by looking at the portfolio turnover ratio and this can show a lot of things about the handling of the overall portfolio.
There are several ratios that are calculated for each of the mutual fund schemes and this is one of them which will point out how the portfolio was handled in terms of the buying and selling of the securities. This ratio will show the extent of the purchases and sales that are taking place in the portfolio and this is usually done over a one year time period. This means that there is a specific time period for which the ratio will be available. The higher the amount of purchases and sales or turnover in the portfolio the higher will be the ratio.
There are two ways in which the ratio can be shown and one of them is the percentage figure where this is something like 100 per cent or 45 per cent. When this is shown in percentage terms it means that out of the total holdings that were present in the portfolio the specified percentage was actually changed or churned during the time period for which the calculations were made. The lower the figure the better it is for the investor as they will find that the higher churning can also lead to a higher cost as far as the overall portfolio is considered.
The second way of looking at the same figure is by giving it a number of times figure so here the figure is shown as 0.5 times or 1.4 times. It means the same thing as was seen above where the extent of the changes are mentioned in relation to the portfolio size so this is just another way in which this is being shown. This means that there can be different ways in which the same figures are shown but it will not change the meaning of the term or what it actually seeks to convey.
Meaning of the ratio
The whole idea behind looking at this ratio is to see whether there is a large amount of churn present in the portfolio of the fund that is being considered for investment. For a lot of investors who think that the mutual funds actually buy shares and then hold them to wait for the results to show up over a period of time then they can be in for a rude shock as in a lot of cases the ratio is actually more than 100 per cent on a consistent basis.
What this actually means is that the mutual fund is churning an equivalent of the entire portfolio in a year's time and this might not be way or the route that the investor expected from their fund manager. Knowledge of this fact will help the investor to make better investment decisions going forward.
A couple of factors get impacted when this kind of large changes in the portfolio is witnessed as this will show that there are only a few, if any, holdings that are present for a long period of time in the portfolio. This means that there will be several companies that keeping coming in or going out and at the same time there is a change in the composition of the fund. This is something that might not work to the advantage of the investor in terms of getting significant benefits from sticking with a particular holding to enable the benefits to play out over a period of time.
At the same time there could be a higher cost element that comes into the picture when this kind of changes are taking place because there will be some cost that will be adding up when the transactions are being undertaken. This will require a closer look to see what is actually happening with the entire portfolio of the fund and whether the behavior results in an extra burden on the investor.
One of the reasons why the portfolio turnover ratio for a fund might be very high is due to the nature of the fund as the corpus could be quite small.
When this is the case then there would be a position where even if there is a small amount of turnover in the holdings of the fund this will result in a larger percentage figure for the overall portfolio.
Thus it might not take much for the portfolio turnover ratio to go higher and hence the size of the fund needs to be taken into consideration when this kind of situation is being looked at.
There is also the problem of managing an open-ended fund which can cause a lot of trouble for fund managers. While they will maintain a certain percentage of the portfolio in cash what is also important is that they are able to meet any redemption requirement or take into consideration additional purchases that will arise when there are new investors entering into the fund. When this is the situation then there will be a position where the portfolio turnover could go higher and hence this will also need to be considered as the very nature of the fund could end up impacting this specific figure. On the whole if this is the case then there is not much that can be done about it but this should form a part of the overall fund planning process.
On the whole it is not an easy decision to make as to what the higher portfolio turnover actually means. What is sure is that when the turnover ratio is lower then it will clearly show that the fund manager is following a buy and hold strategy however there are different interpretations that can be made when the ratio is higher. Many people would like to excuse this kind of situation as long as the fund is able to show the kind of returns that are expected from the fund. There is also no condition that good funds always have a low turnover ratio but the expectation is that if the fund manager is advising investors to invest for the long term then this should also be followed by the fund manager.
Also there could be some trouble in the times ahead as there could be some disruption in the future when the returns would be impacted by the change that is being witnessed on the portfolio turnover side.
All the reasons that might be present for the higher portfolio turnover ratio have to be considered. It is also important that there is a check of the manner in which the ratio is calculated so that there is no wrong comparison that is actually made between different situations just because the workings are actually different.
There is also a position where the final decision about selecting or choosing a particular fund will be determined by several factors and this will just be one of them so there might not be a large impact in the final phase of the entire process. All this will need to be considered and then it has to be put in the context of the overall situation.