Churn is not necessarily burn: debunking the myths of portfolio turnover
There is a widely held assumption that portfolio turnover results in poorer outcomes for investors as a result of the additional costs it incurs. Our research challenges that simplistic assumption by instead focusing on added value net of costs.
We find no evidence of a structural relationship between turnover and excess returns among active US equity funds over the 1991-2016 period.1 This includes small and mid-cap funds, despite the higher costs of trading in these sectors. On average, high turnover active US equity funds have the ability to generate sufficient value to off set additional transaction costs.
Within emerging markets we do find that higher levels of turnover are historically detrimental for performance over a three year horizon and that low turnover is a quality associated with top performing funds, although we must be careful not to confuse correlation with causation. Unlike US small cap funds, the average high turnover emerging market equity fund appears unable to add sufficient value to offset the additional transaction costs it is exposed to. This makes intuitive sense with the higher cost nature of emerging markets a likely key driver.
Choosing the right active fund is always imperative but our analysis suggests that this is even more true among high turnover funds. The best high turnover US equity funds have outperform the best low turnover funds but the worst have done worse and there is an increased likelihood of a high turnover fund failing to survive over time. This last feature has been strongest among growth, small cap and emerging market equity funds.
Finally, high turnover funds have the undesirable feature that they have historically struggled versus low turnover funds in periods of falling markets and rising volatility, on average. This is made more pertinent by the fact that average turnover levels have increased in times of market stress, precisely the times when this characteristic has been detrimental to performance.
The views and opinions contained herein are those of Schroders’ investment teams and/or Economics Group, and do not necessarily represent Schroder Investment Management North America Inc.’s house views. These views are subject to change. This information is intended to be for information purposes only and it is not intended as promotional material in any respect.