A turnover ratio is an important parameter to access various investment options before you invest. It is a measure of the number of times a company’s inventory has been replaced during a given period of time.
A turnover ratio speaks volumes on a fund’s performance, the competence of a fund manager, efficiency of a company when it comes to generating assets and the flow of money in and out of a particular fund over a period of time. It gives you an idea of how frequently the fund manager has bought and sold underlying stocks. A high turnover ratio over a period of time means a lot of stocks have been churned in the portfolio. If the turnover is 100 percent, it means the entire portfolio has been replaced and a low turnover ratio means the fund manager follows a strategy to buy and hold, where he has a very high conviction in his picks.
A high turnover ratio indicates high transactions or trading costs which eventually impact an investor’s return. A high turnover needs to justify the churn with superior returns as high costs would drag down a fund’s performance. High turnovers can be avoided but when investors buy and sell too frequently the fund manager is forced to change and replace the holdings. A lot of shuffling could also mean poor foresightedness and poor decision-making skills.
Having said that, when a portfolio sees high turnovers it could also mean it needs a churn as the rally has completed and the funds have run their mojo, and a low turnover could mean it is time for a review of funds in the portfolio. For mutual funds, a turnover ratio is calculated by dividing the average assets during the period by lesser of the value of purchases and value of sales during the same period. The percentage of the fund’s assets is changed over a course of time which is usually a year.
How to calculate the turnover ratio
In the case of mutual funds, the turnover ratio is the percentage of a fund’s assets that have changed over the course of a given time period, usually a year. Turnover ratio for a mutual fund is calculated by dividing the average assets during the period by the lesser of the value of purchases and the value of sales during the same period.
Turnover ratio = Change in holding % / total holding. For example, if a fund purchased and sold ₹5 crore in assets and had average assets of ₹50 crore, then the resulting answer would be: Turnover ratio = 5/50 = 10 percent.So it is important to assess all your investments before you decide to hop on and hold on to an investment.