Understanding Annual Turnover: Meaning, How to Calculate it, and an Illustrative Example

What Is Annual Turnover?

Annual turnover signifies the rate of change in ownership over a year. Within the realm of business, this metric touches upon yearly turnovers in inventories, receivables, payables, or assets.

In the realm of investments, an annual turnover rate recalibrates a mutual fund or exchange-traded fund’s (ETF) investment holdings on a yearly basis. Portfolio turnover analyzes the assets under management (AUM) in comparison to the inflow or outflow of a fund’s holdings. This figure serves as a tool to gauge the level of activity involved in altering a fund’s underlying positions. High turnover rates typically denote an actively managed fund. Conversely, passive funds exhibit lower holding turnover percentages. Index funds are emblematic instances of passive holding funds.

Key Takeaways

• A turnover rate denotes the number of times an asset, security, or payment transitions hands within a year.
• Businesses utilize annual turnover rates to assess their operational efficiency and productivity, while investment managers and investors leverage turnover rate information to comprehend portfolio activity.
• Annualized turnover often acts as a forward-looking projection based on a shorter investment turnover period, such as one month.
• Merely having a high turnover rate does not inherently translate to superior fund quality or performance.

Calculating Annual Turnover

To compute the portfolio turnover ratio for a specific fund, begin by ascertaining the total value of assets bought or sold (whichever is higher) during the year. Subsequently, divide this figure by the average assets held by the fund throughout the same period.

portfolio turnover = max{fund purchases, fund sales}/average assets

For instance, if a mutual fund manages $100 million in assets and liquidates $75 million during a measurement period, the calculation yields: $75m/$100m = 0.75, where ‘m’ signifies million.

Importantly, a fund displaying a 100% turnover annually does not necessarily mean that all initial positions have been liquidated by year-end. The turnover illustrates the frequent trading of positions and the fact that securities sales correspond to the total AUM for the year. Additionally, using the same formula, the turnover rate factorizes the number of securities acquired during the measurement period.

Annualized Turnover in Investments

Annualized turnover represents a predictive estimate based on a condensed investment turnover window, such as a month. To exemplify, if an ETF displays a 5% turnover rate for February, investors can predict the annual turnover for the upcoming year by multiplying the one-month rate by 12, yielding an annualized holdings turnover rate of 60%.

Actively Managed Funds

Growth funds hinge on trading strategies and stock selection spearheaded by seasoned professional managers striving to outdo the benchmark index. The emphasis lies on holding sizeable equity positions to attain positive shareholder outcomes. Managers consistently outperforming indices retain their positions and attract substantial capital inflows.

While the debate between passive and active management endures, high-volume approaches can yield moderate success. Take for instance the American Century Small Cap Growth fund (ANOIX), a four-star Morningstar-rated fund boasting a vigorous 141% turnover rate (as of February 2021), consistently outperforming the S&P 500 Index over the past 15 years.

Passively Managed Funds

Index funds, like the Fidelity 500 Index Fund (FXAIX), adhere to a buy-and-hold strategy. By doing so, the fund maintains positions in equities as long as the constituents remain integral to the benchmark. These funds exhibit a perfect correlation with the index, resulting in a low portfolio turnover rate of merely 4%. Historically, indices have surpassed managed funds over 60% of the time.

It should be noted that solely evaluating a high turnover rate in isolation does not serve as an indicator of fund quality or performance. Case in point, the Fidelity Spartan 500 Index Fund trailed the S&P 500 by 2.57% in 2020, post-expenses.

Annual Turnover in Business: Inventory Turnover

Businesses employ several annual turnover metrics to gauge the operational effectiveness over a year. Inventory turnover signifies the speed at which a company sells inventory and provides an avenue for comparison against industry norms. A low turnover may imply weak sales or surplus inventory, known as overstocking. Conversely, a high ratio suggests robust sales or inadequate inventory, the former being favorable while the latter could lead to lost business. At times, a low inventory turnover rate may indicate favorable conditions, such as anticipated price hikes or shortages.

The rapidity of inventory turnover serves as a pivotal metric of business performance. Retailers excelling at swift inventory turnover generally outperform their counterparts. Prolonged inventory holding increases costs and diminishes incentives for consumers to revisit for new purchases.