Fund Transactional Activity: This is What You Need To Look For In A Fund. Here’s Why.

Fund transactional activity is one of the most important things to look out for, prior to making an investment decision. Expressed as a percentage, the metric provides a clear insight of how a fund buys and sells assets in a bid to generate shareholders returns.

Fund transactional activity – sometimes referred to as ‘Portfolio Turnover’ – sheds light on the securities, stocks bonds or both, that a firm has bought and sold in a fiscal year. The information is usually available in a number of sources including fund reports and regulatory filings.

Put in a simple way, say a fund had a turnover rate of 50% at the end of the year, it means that 50% of the stocks that it owned at the start of the year were sold and replaced by 50 new ones before the end of the year. A 100% turnover, on the other hand, means a firm replaced all the stocks or securities held at the start of the year by new ones, by the end of the year.

 

Significance of Fund Transactional Activity

If an investment has a high, transactional activity it indicates that it replaces most of its holdings during a calendar year. It also signifies that a fund is actively managed. While increased turnover is indicative of new opportunities discovered, it does not always guarantee maximum returns. Increased turnover is most of the time associated with high costs in the form of transactional fees.

A fund with a low turnover ratio indicates that it follows a certain buy and hold strategy. It also shows that a fund manager has a high conviction with the picks. A high transactional activity, on the other hand, is necessarily not a bad a thing. It is especially good in a rallying market where new opportunities keep cropping up.

Given that, managers don’t incur any costs to buy and sell assets, there seem to be little incentives for them to change their ways when it comes to funds with high transactional activity.

 

Typical turnover ratio/ Transactional Activity for a Fund

Source: Shutterstock

Index Funds

The passive nature of index mutual funds means they should always have a lower turnover ratio in a calendar year. These types of funds are built to track indexes that require low hands-on management. An index fund with a high transactional activity may at times indicate trouble on the management, given that a stock is only added or removed, when an underlying index posts a change.

A transactional activity of more than 30% with indexed funds should always raise a red flag. Lower turnover ratio is advantageous to investors as they translate to lower transactional fees thus maximum returns.

Active Funds

Mutual funds are usually set up to pursue rapid returns over a short period, thus synonymous with high turnover rate. This strategy usually exposes them to more risks given that they have to choose stocks that are undervalued and then sell them when they spike. Aggressive active funds could have turnover ratio of more than 100%

Actively managed funds target to beat the market every time. The reality though, might be very different, and may simply result in higher fees.

Other factors fund investors should look out for

Who Runs the Fund?

The success of any fund after deduction of all the costs depends on the person on the driver’s seat. Investors should always dig deeper to find who is running a fund and more importantly investigate their track record over a long period.

While past performance is no guarantee of future returns, a manager who has proved him/herself for more than 10 years is likely to perform better than who had a just had one stellar year. An impressive record is also indicative of a good transactional activity when it comes to the selection of stocks and securities.

The best fund managers are those ones that deliver returns, consistent with general market returns

 

Read the Fine Print

Taking time to read a fund’s fine print could be an eye-opener on its transactional activity strategy and whether it is paying off. Closer examination of the fine print could help uncover various fees that might be eating into a fund’s returns.

Investment funds make their money by charging investors. A load fee is usually charged when one makes an initial investment or upon the sale of an investment. A front-end load fee is usually paid out of the initial investment made by an investor. A back-end load fee, on the other end, is usually charged when an investor sells his or her investment, prior to a set period.

Taking into consideration the expenses, a fund with high a transactional activity should have impressive returns if investors are to enjoy maximum returns from their investments.

 

Size of the Fund

The size of the fund can significantly affect its turnover ratio thereby affecting investor’s returns. When a fund gets too large it means more money needs to be invested. Many at times managers of these funds struggle to find the right investments, to plow the money.

There is no benchmark to how big a fund should be for optimum returns. However, a fund worth more than $100 billion under management would find it difficult to buy and sell stocks anonymously. When a fund becomes too big, managers are usually restricted on what they can buy consequently affecting their ability to generate returns based on the amounts under management.

Some mutual funds with aggressive strategies boast of higher transactional activity with more returns. However, some funds pay the price of higher turnover as returns take a hit on increased transactional fees. It is thus important for an investor to invest in a fund that knows what it is doing in terms of balancing the transactional activity for optimum returns.

 

 

This article first appeared on ZUUOnline.Sg.

ZUUonline is an Asia-based financial education online portal. Founded in Japan by Kazumasa Tomita, a former private banker at Nomura Securities, the portal seeks to fill the information gap between institutional research houses and the private investor.

(By Neha Gupta)

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