What Is Annual Turnover?

What Is Annual Turnover?

Let me explain annual turnover directly to you: it's the percentage rate at which something changes ownership over the course of a year. For a business, this could relate to its yearly turnover in inventories, receivables, payables, or assets.

In the world of investments, I see annual turnover as the rate at which a mutual fund or exchange-traded fund (ETF) replaces its investment holdings on a yearly basis. Portfolio turnover compares assets under management (AUM) to the inflow or outflow of a fund's holdings. This figure tells you how actively the fund changes the underlying positions in its holdings. If you see high turnover rates, that points to an actively managed fund. On the other hand, more passive funds have lower percentages of holding turnovers—think of an index fund as a classic example of a passive holding fund.

Key Takeaways

You compute a turnover rate by counting how many times an asset, security, or payment changed hands over a year-long period. Businesses examine annual turnover rates to determine their efficiency and productivity, while investment managers and investors use the turnover rate to understand the activity of a portfolio. Annualized turnover is often a future projection based on one month—or another shorter period—of investment turnover. Remember, a high turnover rate by itself is not a reliable indicator of fund quality or performance.

Calculating Annual Turnover

To calculate the portfolio turnover ratio for a given fund, you first determine the total amount of assets purchased or sold—whichever is greater—during the year. Then, divide that amount by the average assets held by the fund over the same year. The formula is straightforward: portfolio turnover equals the maximum of fund purchases or fund sales, divided by average assets.

For instance, if a mutual fund held $100 million in assets under management (AUM) and $75 million of those assets were liquidated at some point during the measurement period, the calculation comes out to 0.75, or 75%. It's important for you to note that a fund turning over at 100% annually hasn't necessarily liquidated all positions it started the year with. Instead, the complete turnover accounts for frequent trading in and out of positions, where sales of securities equal total AUM for the year. You can also measure the turnover rate using the same formula based on the number of securities bought in the measurement period.

Annualized Turnover in Investments

Annualized turnover is a future projection based on one month—or another shorter period—of investment turnover. Suppose an ETF has a 5% turnover rate for the month of February; you can estimate the annual turnover by multiplying that one-month figure by 12, giving you an annualized holdings turnover rate of 60%.

Actively Managed Funds

Growth funds rely on trading strategies and stock selection from seasoned professional managers who aim to outperform the index that the portfolio benchmarks against. Owning large equity positions is more about achieving positive shareholder results than committing to corporate governance. Managers who consistently beat the indices keep their jobs and attract significant capital inflows.

While the debate between passive and active management continues, high-volume approaches can achieve moderate success. Take the American Century Small Cap Growth fund (ANOIX), a four-star-rated Morningstar fund with a 141% turnover rate as of February 2021, which outperformed the S&P 500 Index consistently over the last 15 years through 2021.

Passively Managed Funds

Index funds, such as the Fidelity 500 Index Fund (FXAIX), adopt a buy-and-hold strategy. They own positions in equities as long as those remain components of the benchmark. These funds maintain a perfect, positive correlation to the index, resulting in a portfolio turnover rate of just 4%. Trading activity is limited to purchasing securities from inflows and occasionally selling issues removed from the index. Historically, indices have outpaced managed funds more than 60% of the time.

Again, it's crucial for you to understand that a high turnover rate judged in isolation is never an indicator of fund quality or performance. For example, the Fidelity Spartan 500 Index Fund, after expenses, trailed the S&P 500 by 2.57% in 2020.

Annual Turnover in Business: Inventory Turnover

Businesses use several annual turnover metrics to understand how well the operation is running on a yearly basis. Inventory turnover measures how fast a company sells inventory, and analysts compare it to industry averages. A low turnover implies weak sales and possibly excess inventory, known as overstocking, which might indicate problems with the goods or insufficient marketing. A high ratio implies strong sales or insufficient inventory—the former is desirable, but the latter could lead to lost business. Sometimes a low inventory turnover rate is beneficial, such as when prices are expected to rise or shortages are anticipated, allowing inventory to be pre-positioned.

The speed at which a company can sell inventory is a critical measure of business performance. Retailers that move inventory out faster tend to outperform others. The longer an item is held, the higher its holding cost, and the fewer reasons consumers have to return for new items.