What is 'Annual Turnover'

Annual turnover is the percentage rate at which a mutual fund or an exchange-traded fund (ETF) replaces its investment holdings on an annual basis. Turnover is meant to measure either inflows and outflows compared to assets under management (AUM) and report on the level of trading activity in the fund.

BREAKING DOWN 'Annual Turnover'

Annual turnover is a good way to inspect the average time horizon of a fund. Higher turnover levels generally add to the expense ratio of a fund and increase capital gains distributions. Benchmark funds such as the S&P 500-matching SPDRs have very low turnover, usually less than 10% per year. On the other end of the spectrum, some funds employ active trading strategies that push annual turnover past 100% annually.

High turnover rates apply to actively managed funds, while passive portfolios such as an index fund have very low turnover ratios. To calculate the turnover ratio for a given fund, the total amount of assets purchased or sold during the year must be obtained. If a fund holds $100 million in AUM and $75 million of those assets are liquidated at some point during the measurement period, then assets sold/AUM = turnover rate, or 75%. It is important to note a fund turning over at 100% annually has not necessarily liquidated all positions with which it began the year; rather, the complete turnover accounts for frequent trading in and out of issues and the fact sales of securities equal total AUM for the year. Using the same formula, the turnover rate is also measured by the amount of securities bought in the measurement period.

Actively Managed Funds

Growth funds rely on trading strategies and stock selection from seasoned professional managers who set their sights on outperforming the index against which the portfolio benchmarks. Owning large equity positions is less about a commitment to corporate governance than it is a means to positive shareholder results. Managers who consistently beat the indices stay on the job and attract significant capital inflows. While the passive versus active management argument persists, high volume approaches realize moderate success. Consider the Alger Capital Appreciation Fund, a four-star rated Morningstar fund with a frenetic 141% turnover rate that outperformed the S&P 500 Index in six of the last 10 years through 2015.

Passively Managed Funds

Index funds such as the Fidelity Spartan 500 Index Fund adopt a buy-and-hold strategy that owns positions in equities as long as they remain components of the benchmark. Maintaining a perfect positive correlation to the index, the portfolio turns over at a rate of 5%. Trading activity is limited to purchasing securities from inflows and infrequently selling issues removed from the index. As indices historically outpace managed funds greater than 60% of the time, a high turnover rate is never an indicator of fund quality or performance. The Fidelity Spartan 500 Index Fund, after expenses, returned 9 basis points less than the 1.4% mark of S&P 500 in 2015 with dividends reinvested.

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