Turnover is defined so that client flows do not count, which makes it a measure of the manager's own trading and a quick estimate of what that trading costs.
Portfolio turnover is the lesser of the year's purchases and sales of long-term securities, divided by the average monthly value of the portfolio. With illustrative purchases of 330, sales of 296 and average assets of 400.0, turnover is 296 / 400.0 = 74.0 per cent, which implies an average holding period of 1.35 years and, at a 0.20 per cent one-way trading cost, about 31 basis points a year of return lost to trading.
Worked in full in Asset Management by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
The convention most fund documents use follows the US Form N-1A instruction: take the lesser of purchases and sales for the year, excluding securities with a maturity of one year or less when acquired, and divide by the average of the monthly values of the portfolio. Each element has a purpose.
| Month end | Value of portfolio securities |
|---|---|
| Opening | 380 |
| Months 1 to 6 | 385, 392, 388, 395, 402, 398 |
| Months 7 to 12 | 405, 410, 404, 412, 415, 414 |
| Average of the 13 values | 400.0 |
| Purchases of long-term securities in the year | 330 |
| Sales of long-term securities in the year | 296 |
| One-way trading cost: commission, spread and market impact | 0.20% |
Turnover = min(purchases, sales) ÷ average monthly value of the portfolio
Average holding period, years = 1 ÷ turnover
Trading cost drag ≈ (purchases + sales) × one-way cost ÷ average value
Excel, month-end values in B2:B14: =MIN(Purchases,Sales)/AVERAGE(B2:B14) and =(Purchases+Sales)*Cost/AVERAGE(B2:B14)
Average value: the 13 month-end figures sum to 5,200, so the average is 400.0. The lesser of purchases and sales is 296. Turnover is 296 / 400.0 = 74.0 per cent. The other 34 of purchases is the money that came in during the year and was invested.
Holding period: 1 / 0.74 = 1.35 years, about 16 months.
Cost: 330 + 296 = 626 traded at 0.20 per cent is 1.252, or 0.31 per cent of average assets, 31 basis points. The part that comes from the manager's own decisions, 2 × 296 × 0.20 per cent = 1.184, is 30 basis points.
| Method | Turnover |
|---|---|
| Lesser of purchases and sales / average monthly value | 74.0% |
| Lesser / year-end value | 71.5% |
| Average of purchases and sales / average value | 78.2% |
| Greater of purchases and sales / average value | 82.5% |
| Purchases plus sales / average value | 156.5% |
The last row is sometimes called two-sided turnover and appears in some institutional reports. It is twice the scale of the standard ratio, so a figure of 156.5 per cent from one source and 74.0 from another can describe the same year. Always ask which definition a reported turnover uses.
| Turnover | Holding period, years | Drag at 0.20% one way, bp | Drag at 0.50% one way, bp |
|---|---|---|---|
| 20% | 5.0 | 8 | 20 |
| 50% | 2.0 | 20 | 50 |
| 75% | 1.3 | 30 | 75 |
| 100% | 1.0 | 40 | 100 |
| 200% | 0.5 | 80 | 200 |
The drag is two times turnover times the one-way cost, because every holding replaced is sold and then bought. The costs are illustrative; small-cap and emerging market equities cost several times what liquid large caps do, so the same turnover can be cheap in one mandate and expensive in another. None of this cost appears in the management fee or the ongoing charges figure; it is netted inside the return, which is why it is easy to overlook when comparing a fee schedule like a tiered management fee.
Reading turnover as a measure of activity in absolute terms and comparing it across definitions or across strategies. A 74.0 per cent figure is unremarkable for an active equity fund and alarming for a fund marketed as long-term and concentrated, where it suggests the stated holding period of several years is not what happens. The second mistake is ignoring turnover when a manager is replaced: the transition trades of replacing a fund manager are a one-off, but a successor that runs at twice the turnover pays a version of that cost every year.
Turnover also interacts with active share. A high active share and low turnover is a manager holding conviction positions; low active share and high turnover is a manager trading around the index, paying trading costs to stay close to it.
The book follows one mandate through every return and cost its stakeholders quote, and the free workbook for this case reproduces the figures.
There is no single good level; it should match the strategy. A buy-and-hold equity fund may run at 20 per cent, a holding period of five years, while an active fund at 100 per cent replaces its portfolio every year. What matters is the cost: at a 0.20 per cent one-way cost, 100 per cent turnover drags returns by about 40 basis points a year, and at 0.50 per cent by 100.
To strip out trading forced by client flows. A fund receiving net inflows buys more than it sells, and the excess is investment of new money, not a decision to replace holdings. In the illustration purchases of 330 exceed sales of 296 by 34; using the greater figure would report 82.5 per cent instead of 74.0.
Divide one by the turnover ratio. At 74.0 per cent the average holding is replaced every 1.35 years, about 16 months. At 200 per cent it is half a year. The figure is an average across the book: a few rapidly traded positions can sit next to long-held core holdings.
This article is one calculation from Asset Management. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
Get the book on Amazon →Free companion files
Also on Amazon UK · Amazon Germany · Amazon France · Amazon Canada
Reading guide: corporate finance, valuation and markets → · All 1501 articles →
If this book helped, or didn’t, a few lines on Amazon are worth more than they look: they are what the next reader goes on. Write a review. The workbook stays free either way.