A crucial concept in finance is that of “portfolio turnover,” which refers to the frequency by which assets in a particular portfolio are bought and sold. The math is very simple: Turnover equals Minimum amount of securities bought or sold divided by the average net assets. So a fund with $100 million in assets on average that purchased $10 million in assets and sold $4 million would have (4/100)=4% portfolio turnover ratio.
The concept is crucial for a couple of reasons. One is taxes: higher turnover typically means more of a tax burden, which is why one of the arts of portfolio management is minimizing turnover for this reason. Another is costs: turnover involves trading and transaction fees, which can lower portfolio returns over time.
While fundamental investing requires a model to determine the target price of an asset (which then becomes the basis for purchasing and selling decisions), a secondary model of optimizing portfolio management with these considerations is layered on top of that. A fund will then decide whether to buy and sell not only based upon an asset’s future value potential, but also on how it impacts the portfolio as a whole.
Portfolio turnover has another value, however; in alternative assets like private equity, a higher turnover rate is sometimes seen as a desirable piece of evidence that the fund is active in a competitive investing environment. In active funds trading stocks and bonds, high turnover may be seen as proof that the fund is identifying hidden value. And in high-frequency trading funds, high turnover is a core characteristic of the fund itself.
Understanding portfolio turnover and how different firms incorporate this concept into their broader models and investment decisions is crucial to understanding how large players in capital markets not only pick investments, but also manage the very large and often unwieldy collection of assets and capital they are in charge of.