I’ve just got a general knowledge type question. Reading 7 Example 11 has the following information:
“Table 20 gives the yearly portfolio turnover for the 10 U.S. equity funds that composed the 2002 Forbes Magazine Honor Roll. Portfolio turnover, a measure of trading activity, is the lesser of the value of sales or purchases over a year divided by average net assets during the year.”
Can someone elaborate a little on the portfolio turnover notion? Perhaps an example, I don’t understand the explanation provided. Just curious to know.
P.S. I’m not sure why it says United States for me, I’m in Australia
Portfolio turnover is used to measure how often the Portfolio holdings are “turning over” (no kidding, right?) Let’s say for example that a Portfolio’s turnover is 100% for a given year. This would mean that the manager’s portfolio is essentially completely sold and invested into new securities during the year. A caveat of the metric is that this does not necessarily mean that every position in the portfolio at the beginning of the year is sold, but rather that the level of trading reflected that the manager’s transactions during the year totaled the entire portfolio market value.
Another example. Turnover is 50%. For simplicity, there are no external cashflows and the total return for the year is 0%. Market value is a steady $100mm during the year. During the year the PM sold $50mm in securities and invested the proceeds in $50mm of new securities. $50mm in sales / $100mm market value = 50%.
Sometimes investors analyze turnover to see if the PM is doing too much trading which can be costly and a detractor if the trades are not adding commensurate value to the portfolio. On the other side, turnover too low in an actively managed fund could be a cause for concern that the PM is not trading enough to capture market mispricings, etc.