Among a plethora of tools that are used by investors to serve as a powerful indicator of the fund’s activity and performance, the Portfolio Turnover Ratio is one. It helps reveal the dynamic nature of the holding of a portfolio, offering a spotlight on the frequency with which the fund’s investments are bought and sold. If you are unaware of what is portfolio turnover ratio, this article will help you to learn about what a portfolio turnover ratio in mutual funds is, its significance, and how to calculate it.
What Is Meant By Portfolio Turnover Ratio?
The Portfolio Turnover Ratio (PTR) is a type of financial metric that helps in measuring the level of trading activity within the investment portfolio, especially in the context of ETFs (Exchange Traded Funds) and mutual funds. Portfolio Turnover Ratio helps in quantifying the frequency of the holdings of a mutual fund purchased and sold by fund manager within a particular period, usually over a single year.
The Portfolio Traded Ratio is typically expressed as a percentage. It reflects the proportion of the assets of the fund that have been turned over or replaced through the activities concerning trading.
How to Calculate Portfolio Turnover Ratio?
Here is a complete guide on how to calculate the portfolio turnover ratio:
Determine the total value of the securities that have been bought and sold throughout the year.
Calculate the total average value of the portfolio over the period.
Divide the activity of trading by the average value of the portfolio.
To express the ratio as a percentage, multiply the result by 100
For instance, suppose a mutual fund has 100 crores in trading activity and an average portfolio value of 500 crores during the entire year; then, the Portfolio Turnover Ratio will be calculated as 100 crores / 500 crores * 100 = 20%
What Does High Portfolio Turnover Ratio Reflect?
A high Portfolio Turnover Ratio signifies a high level of trading activity within the portfolio, which is typically associated with investments in ETFs and mutual funds. Funds with high PTR reflect that a considerable portion of the fund’s assets have been bought and sold over a year.
What Does Low Portfolio Turnover Ratio Reflect?
On the other hand, low PTR signifies a low level of traditional activity in the investment portfolio involving ETFs and mutual funds. A fund entertaining a low PTR represents that a small portion of the asset of the fund has been bought and sold during a specific year, especially over a year.
Does Portfolio Turnover Ratio Help In Evaluating Mutual Funds?
Yes, the Portfolio Turnover ratio serves as a helpful metric for the evaluation of mutual funds. It offers valuable insights into the investment strategy of the fund and trading activity, as well as carries potential implications for investors. The various ways in which PTR can help in the evaluation of mutual funds are as follows:
Investment Strategy And Style:
PTF provides a glimpse into the investment style of the fund. High PTR represents that the fund is actively managed with a frequent strategy for trading. On the other hand, a low PTR represents a buy-and-hold or passive approach. Knowing the investment style of the fund is crucial in aligning it with the objectives and risk tolerance ability of your investment.
Expenses And Costs:
Portfolio Turnover Ratio has a direct impact on the transaction cost of the fund. As a high PTR implies more frequent trading, it results in higher brokerage costs and transaction fees. These expenses can reduce the overall return of the fund, making it a less cost-effective option for investors. On the other hand, funds having a low PTR comes with a lower cost of the transaction, thereby offering a more cost-effective investment.
Tax Efficiency:
PTR also has a significant influence on the tax efficiency of the fund. High PTRs may result in more frequent capital gains realisations, which in turn triggers increased capital gains for investors. Funds with low PTR being more tax efficient, offer a more feasible choice for taxable accounts.
Stability And Consistency:
Portfolio Turnover Ratio offers a comprehensive insight into the turnover ratio of the fund. A low PTR indicates that the portfolio is stable, involving minimal charges. This usually results in a consistent performance over a long period. Therefore these funds are preferred by investors for seeking consistent returns and less exposure to market volatility over the short term.
Evaluation Of Active Management:
For funds entertaining high PTR, investors need to evaluate the active management strategy of the fund. A successful active fund manager must be able to generate excess returns that justify the increased cost associated with trading frequently.
Alignment With The Goals And Objectives Of The Investment:
Evaluating the portfolio turnover ratio in a mutual fund or ETF in the context of your investment goal and time frame proves helpful in identifying specific funds that abide by your financial objectives. A low PTR may be a perfect option for a long-term investor, while active investors may choose funds with a high PTR.
Conclusion
However, it is essential to note that PTR is a precious metric in the oeuvre of investment but must not be considered as a sole factor while evaluating mutual funds. Only through a thorough understanding of PTR with other relevant factors such as expense ratio, historical performance, and risk-adjusted returns can an investor make informed investment decisions that align with their financial preferences and goals.
Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
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