Fund Pointer: Churning Pot

When fund managers churn portfolios to capture momentum and ride the short-term cycles, performance invariably takes a hit 

Old habits die hard for many fund managers. Instead of making wise long-term investment decisions, some of them behave like traders and churn portfolios—their churning ratios going as high as 200%. Though they profess not to, many try to time the market, trade in derivatives and change their equity exposure at will. Out of the total 216 equity diversified schemes currently available in the market, 48 schemes have a churning ratio of more than 100%!
Many fund advertisements have an illustration of how a stock held over years can fetch handsome returns. They emphasise the importance of a buy-and-hold strategy. Sadly, many fund houses don’t seem to practise what they preach. The truth is: many fund managers try to chase momentum. Sometimes, they buy and sell the same stocks erratically for no sound reason.
This behaviour goes completely against the grain of mutual fund investing—making investments and staying invested for the long term. A high portfolio turnover does not necessarily lead to higher returns. On the contrary, returns often get eroded as a result of constant churning. The portfolio turnover ratio indicates the frequency of trades carried out by the fund manager—or the number of times he buys and sells stocks. Take, for instance, ICICI Prudential Growth Plan, which has yielded only 7% returns since inception, with a portfolio turnover of 232%. The ICICI Prudential Service Industries Fund too has provided returns of just 9% on its way to recording a turnover ratio of 231%. DSP BlackRock Top 100 Equity Fund recorded a churning ratio of 316% till March 2010. Returns were 6%. Similarly, the IDFC Enterprise Equity Fund, with a high turnover ratio of 206%, has managed to yield returns of just 3% since inception until March 2010. Others with a significantly higher turnover ratio but measly returns include Sahara Growth Fund, IDFC Strategic Sector (50-50) Equity Fund and JM Hi Fi Fund. On an average, schemes with a portfolio turnover ratio higher than 100% have yielded returns of 8% since inception.
On the other hand, schemes with comparatively low churning ratio (less than 100%) have provided better results. They have yielded 9% returns, on an average, since inception. Maybe returns have nothing to do with the number of times you buy and sell your holdings. The Templeton India Growth Fund, with a churning ratio as low as 8%, has managed to deliver 16% returns since inception. HDFC Mid-Cap Opportunities Fund has yielded 18% returns since inception with a churning ratio of 20%. Similarly, funds like the Tata Dividend Yield Fund (16%) and Reliance Equity Opportunities Fund (20%) have put in a decent performance, despite recording low churning ratios of 19% and 46%, respectively.
But that doesn’t mean that churning should not be practised at all. Slight churning of the portfolio every six months is advisable for a variety of reasons—to re-balance the portfolio and to account for drastic changes in the outlook for particular companies or sectors. However, constant and extravagant churning, as highlighted above, puts the portfolio under severe strain and the scheme ends up losing out in the long run. Interestingly, this is what fund managers preach, by and large. If this is supposed to be true for your individual investments, why should it not apply to fund companies?