Monday, 30 November 2015

Portfolio Turnover Ratio: how fund managers go about stock selection?

Have you ever wondered how fund managers go about stock selection? Do they adopt a buy and hold approach or do they look for short term gains by focusing on momentum? No matter how hard you try, it’s not possible to chase a fund manager’s approach all the time. However few metrics can help you know more about a fund manager's investment style.

One such key metric is the Portfolio Turnover Ratio (PTR). It indicates the traded frequency of stocks of the respective portfolio in the previous year. A higher PTR implies hectic buying and selling while a lower PTR implies low trading activity. A PTR of 1 means the fund manager has churned the entire portfolio at least once in the given period. Funds with higher PTR point to a 'dynamic' investment style which implies that fund manager utilizes the cash more aggressively compared to what one does for conventional low-risk equity funds. One must bear in mind, though, that PTR is not an assigned mandate, it only reflects the manager’s investment style.

Going by past records, funds with a consistently lower PTR have delivered better returns compared to funds with a higher PTR. Those fund houses that swim against the current or those who shun the rat race find it prudent to adopt a buy-and-hold approach rather than chasing stock momentum. A higher PTR also implies higher transaction costs which over time can cumulatively erode a substantial part of your fund returns.  

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