So while the cheapest quintile beats the next-cheapest quintile and so on, turnover didn't work that way. While fees, stars, and manager tenure produced a nice stair-step down, the turnover results were lumpier. Overall, turnover proved to have a smidgen of predictive power, but it was not as strong or consistent as the best predictors. Were we to run the data including expenses, we might find noisy results in which low turnover simply captured low costs in the form of index funds. The lowest-cost funds are mostly index funds, and those funds generally have low turnover. I wanted to separate turnover from expenses. Also, asking whether a fund survived is a way of accounting for the fact that many weak-performing funds are killed off each year in a way that can skew studies of fund data.įor turnover, I added another wrinkle. The idea is to use real data that existed in the past and see how one might have done using that past data rather than using today's data and projecting backward. If another group had a 20% rate, you know the former was better than the latter. So, a 40% success rate over a five-year period tells you that 40% of the funds in a certain group survived and outperformed. We calculated returns and success rate to find out what the chances are that a fund would survive and outperform its peers over the ensuing period. Using rolling five-year periods beginning in 2000, we ran a test that was similar to past tests of predictive value. A maturing bond constitutes a sale, so a short-term bond fund where most of the holdings are maturing in a year will run near 100% turnover simply by buying an equal amount of bonds to replace the ones that mature. In that case, the turnover rate would be significantly understated.īond funds present an additional challenge. If a fund has had large inflows or outflows in a year, the managers may have made far more purchases than sales or vice versa. However, by choosing the lesser of the two rather than summing them and dividing by 2, the SEC is allowing some quirky results to sneak in. The SEC uses purchases or sales rather than both because that would be double-counting. It doesn't actually mean he's held nothing for more than one year-he may have held half the portfolio unchanged throughout the year and turned over the other half twice. As you'd expect, a 100% turnover ratio means the manager has turned over an amount of shares equal to the total value of the portfolio. The algorithm is a sum of the dollar value of the lesser of purchases and sales during the fiscal year divided by average net assets over that period. The SEC mandates how fund companies calculate turnover, and that method could stand to be updated. I'll walk you through what turnover means, how I tested it, what the tests show, and finally, what turnover tells you about a fund's strategy. Because many investors use it in their selection process, I thought I'd put turnover through the paces to see where it shakes out versus the other data points. Last year I examined the predictive power of a number of data points, but I didn't test turnover.
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