What does the turnover ratio of mutual fund signify? How can be it used to analyse a fund?
A mutual fund scheme's turnover ratio tells you how frequently its fund manager buys and sells the underlying stocks. Higher the turnover ratio, more your fund manager churns the scheme's portfolio. For instance, a turnover rate of 100 per cent implies that the fund manager has replaced his entire portfolio during the given period. Technically, the turnover ratio is the lower of the total sales or total purchases over the period divided by the average of the net assets.
Turnover ratio indicates the way a fund is managed. A fund that moves in and out of stocks aggressively, in pursuit of quick gains upon spotting opportunities, will tend of have a high turnover ratio. On the other hand, a fund following buy-and-hold strategy will have a much lower turnover ratio.
Besides, a high portfolio turnover means the fund has to incur more transactions costs which are passed on to the investors in the form of expenses charged to the fund. Such funds need to justify it with superior returns, else higher costs can drag their relative performance down.