Profit Using High And Low Turnover Funds

By Will Ashworth | September 21, 2009 AAA

The average annual turnover rate for stock funds is not as high as you might think. According to the 2008 Investment Company Institute fact book, the average annual turnover was 59%, right on the 35-year average and much lower than turnovers experienced in the mid-1980s when they were in the 80% range. Now I don't spend a great deal of time studying mutual funds but that number seems awfully low. As it turns out, it's irrelevant. Mutual fund turnover ratios have little correlation with fund quality. There are top performing funds with both high and low turnover ratios. At the end of the day, it matters only that they perform. (Learn about mutual fund turnover in our article Turnover Ratios Weak Indicator Of Fund Quality.)


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Diverging Styles
In the last few years there have been two star funds that sit at opposite ends of the spectrum. Ken Heebner's CGM Focus (CGMFX) fund has a current turnover rate of 504% and a five-year annualized rate of return of 8.89%, putting it in the top 2% of its large growth category. Also in the large growth category and in the top 2% is the Amana Trust Growth (AMAGX) fund with a current turnover rate of 7% and a five-year annualized rate of return of 9.45%. Both handily beat the S&P500 and the average large growth fund by 7-8% annually. How they got that performance are two entirely different stories. I won't get into that today. Instead, I'll concentrate on each fund's top five holdings and whether any in the group are worthy of your investment consideration.

CGM Focus Top Five Holdings

Company Market Cap
Ford (NYSE:F) $22.0B
Goldman Sachs (NYSE:GS) $93.24B
Amazon.com (Nasdaq:AMZN) $39.10B
Baidu (Nasdaq:BIDU) $13.85B
J.C. Penney (NYSE:JCP) $7.87B

Blink and You'll Miss It
CGM Focus' top holdings are from its latest June 30 quarterly holdings report. Given Mr. Heebner's penchant for turning the stocks in his portfolio, it's doubtful his current top five are the same. Nonetheless, I'll have a look at the fundamentals for each, assessing their chances for long-term success.

Ford has had the most success in the past year, gaining market share in 10 out of the last 11 months. As well, the cash-for-clunkers program put some additional wind in its sales. Having said that, the competition for consumers is intense and its $133 billion in debt is staggering. I'd avoid it.

Goldman Sachs is flying. Second-quarter earnings were a record $4.93 a share, and Q3 earnings will probably be almost as stellar. FBR Capital Markets analyst Steve Selmach raised 2009 EPS to $16.21 from $14.68 and 2010 EPS from $16 to $18. Even though the company's stock is up 116% year-to-date, Selmach believes it has room to move, and in the long term, so do I.

What can I say about Amazon.com that hasn't already been said? Later this year the company's revenue from merchandise other than books, music and movies will overtake the product categories that made it an internet star. I'd never bet against Jeff Bezos. This one's a no-brainer.

Some consider Baidu the Chinese version of Google. Personally, with all the trouble it's currently facing over illegal MP3 downloads from its search engine, I'd stay away.

Lastly, J.C. Penney's back-to-school sales were disappointing, dropping 7.9% in August. Mike Ullman's a good CEO, but his stores have been too inconsistent. I'd pass. (Read Analyzing Retail Stocks to learn about the most important metrics to look at when analyzing retail stocks.)



Amana Trust Growth Top Five Holdings

Company Market Cap
Apple (Nasdaq:AAPL) $163.95B
Humana (NYSE:HUM) $6.64B
Hewlett Packard (NYSE:HPQ) $111.00B
Intel (Nasdaq:INTC) $109.89B
Novartis (NYSE:NVS) $111.82B

An Islamic Point Of View
The Amana Trust Growth fund is a different breed. In existence since 1994, it invests based on Islamic principles, which prohibit it from buying companies involved in liquor, gambling, insurance and all interest-based financial institutions including banks. Managed by Nicholas Kaiser since inception, you can bet the top stocks in his fund won't be changing that often with such a low turnover rate. Kaiser's top five are far safer than Heebner's. With the exception of Humana, these stocks are all giant caps whose profits in the latest twelve months totaled $22.6 billion. As for Humana, it hasn't done much year-to-date due to uncertainties created by the ongoing health care reform debate. Up 4.4% compared to 18.6% for the S&P 500, it's a cash cow with almost as much cash per share as its $39.75 stock price. Fear is keeping this one down. I'd dive in.

Bottom Line
Out of 10 stocks, I like two of Heebner's (Amazon and Goldman Sachs) and all five of Kaiser's. Those alone would make a strong portfolio.

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