A friend asked, when selecting funds, should the turnover rate be considered as an indicator? Is this indicator helpful for investing in funds?

First, let's state the conclusion:

It is helpful.

When we select funds, we tend to choose those with a relatively lower turnover rate compared to their peers.

However, the turnover rate is a less significant consideration.

It is usually considered after taking other factors into account.What is Turnover Rate?

The turnover rate of a fund refers to the proportion of the stocks held by the fund manager that are bought and sold annually, relative to the total value of the stocks they hold.

For example, if a fund manager buys and sells all the stocks they hold within a year, then the turnover rate would be 100%. This data can often be found on some fund websites.

In simple terms, the turnover rate represents the frequency with which the fund manager buys and sells stocks and adjusts their portfolio.

Suppose a fund manager identifies a particular investment and patiently holds onto it for a long time, only selling when the investment has significantly appreciated to an overvalued level or when a selling point emerges.The method of holding for a longer period without moving will result in a lower turnover rate.

Advertisement

Conversely, for example, fund managers who like to follow market hotspots and frequently change the stocks they hold will have a higher turnover rate.

The impact of turnover rate on fund returns

Overall, a turnover rate that is too high is detrimental to the returns of a fund.

Research indicates that funds with the lowest turnover rates, compared to funds with higher turnover rates, have an average annual return that is about 0.7% higher.The reasons for this situation are mainly as follows:

(1) Fund managers trade too frequently, unable to hold long-term, missing market rallies.

The A-share market itself has the characteristic of long bear markets and short bull markets, requiring sufficient patience.

Market surges only occur in 7% of the time, and the other 93% of the time is either a decline or a horizontal fluctuation.

However, if fund managers trade frequently, they may miss out on this 7%.

To put it in a phrase, "We need to be present when the lightning strikes."(2) Frequent buying and selling implies higher transaction costs.

Every time a fund manager buys or sells a stock, regardless of whether they make a profit, fees such as stamp duty and handling fees must be paid.

The more frequent the buying and selling, the more transaction costs are incurred, which can also erode a portion of the returns.

(3) For funds, holding stocks for a short period also means having to pay higher dividend taxes.

In A-shares, when a fund sells stocks:

• If the holding period is less than one month, a 20% dividend tax must be paid;

• If the holding period is between one month and one year, a 10% dividend tax must be paid;• If the holding period exceeds 1 year, dividend tax is exempted.

It should be noted that fund managers cannot completely avoid buying and selling stocks.

Because of investors' subscriptions and redemptions, it also leads to the need for fund managers to trade stocks.

Therefore, sometimes, the behavior of investors can also cause changes in the fund's turnover rate.

What is an appropriate turnover rate for a fund?

▼ Active fundsFor actively managed funds, a stock turnover rate of less than 200% is considered relatively low.

If an active fund manager's turnover rate exceeds 200% or even higher, caution is warranted.

For actively selected advisory portfolio, the fund managers selected mostly have a long-term average turnover rate of around 50%-100%, which is a lower level.

For index funds, a stock turnover rate of 50%-100% is common.Most indices undergo 1-2 rebalancings each year, which involves swapping out stocks, and the corresponding index funds will also adjust the stocks they hold accordingly.

However, the rebalancing of index funds is automatically completed by the fund company, without any action required from the investors.

**Advisory Portfolios**

Advisory portfolios also have strict limitations on turnover rates, with a regulation that the annual turnover rate must not exceed 200%. This standard is similar to that of actively managed funds with lower turnover rates.

For our several advisory portfolios, the frequency of rebalancing is quite low, occurring only once or twice a year.The proportion of each portfolio adjustment is also relatively small, far below the average turnover rate level.

Therefore, there is no need to worry about frequent trading in the advisory portfolio, which would result in higher transaction fees.

In addition, the portfolio adjustments of the advisory portfolio are also carried out automatically, without the need for investors to do anything, which is more worry-free and labor-saving.

Turnover rate is just an auxiliary reference indicator

When selecting funds, the turnover rate is just an auxiliary reference indicator.

It is usually considered as an auxiliary reference after taking into account the investment strategy, investment style, and investment ability of the fund manager.Just like getting married, it is necessary to first assess important factors such as character, ability, and family, before considering whether there are any minor daily quirks.

The best-case scenario is when there are no issues with the significant aspects, and there are no minor quirks either.