It's a general rule of thumb that you should monitor your investment portfolio regularly, with an eye to adjusting and rebalancing about once a year. And many investing pundits espouse the tried-and-true buy-and-hold method, insisting that, like gambling, the more you play the more you lose.
By that logic, replacing your entire portfolio on a quarterly or monthly basis would be tantamount to financial self-immolation. But after comparing the funds with the highest turnover vs. the lowest turnover, TheStreet.com Ratings team found conventional wisdom turned on its head.
We screened stock and hybrid open-end mutual funds with "A" and "B" buy-recommendation grades that had the highest and lowest turnovers. Some of the funds on the high turnover list had annual portfolio turnover rates well over 1,000%, which translates to an average overhaul of once a month.
Contrary to the buy-and-holders' theory, the average high-turnover fund achieved greater average returns than the low-turnover group for the year to date, latest 12 months and past three years.
However, as might be expected, the higher-turnover funds also commanded higher fees, with an average expense ratio of 1.6%, compared with 1.07% for the low-turnover funds. Also, with these funds you will have to pay taxes at the short-term capital gains rate.
But regardless of whether the fund was in the high- or low-turnover category, the average fund on both lists outperformed the
total-return index for the three time periods. All but one fund on the list of high turnovers beat the S&P for the year to date as well as for the past year, while all outdistanced the gauge for the past three years.
With the exception of a trio of Pimco institutional funds, the members of the top 10 turnover list are from the
family. A pioneer in leveraged and "inverse" funds, Rydex has developed considerable in-house expertise over the years in the efficient use of options, futures and other derivative instruments in efficient portfolio management.
Pimco has developed similar skills by using some exotic instruments to squeeze above-average returns out of its fixed-income funds, the firm's traditional area of expertise.
Rydex's regulatory filings for funds on the list note that options, futures, options on futures and swap agreements are included in its arsenal of portfolio management tools. Pimco, in its
Securities and Exchange Commission
filings, notes similar stratagems for its members of the hyperactively managed funds list.
Because the various derivative instruments used by Rydex and Pimco typically expire after a few months, the ongoing process of rolling over the investments into fresh paper results in high portfolio turnover.
Excessive turnover, in less capable hands, can result in some serious drags on performance. Trading commissions, losses on bid-asked spreads and other related costs can depress returns.
But investment firms such as Rydex and Pimco, now a unit of
, have learned to manage portfolios using computer-driven strategies that produce cost-efficient returns by monitoring a broad selection of instruments and timing trades with a precision well beyond the capability of even a team of humans.
In addition to having better returns, five of the high-turnover funds earned grades in the A range from the TheStreet.com Ratings, with two of them receiving the highest possible A-plus ratings. That surpassed the low-turnover group, with three members achieving grades in the A range, one of which was an A-plus.
So while the efficiencies of low portfolio turnover can equate with index-beating returns, funds with startling turnover ratios shouldn't be denied consideration.
Richard Widows is a financial analyst for TheStreet.com Ratings. Prior to joining TheStreet.com, Widows was senior product manager for quantitative analytics at Thomson Financial. After receiving an M.B.A. from Santa Clara University in California, his career included development of investment information systems at data firms, including the Lipper division of Reuters. His international experience includes assignments in the U.K. and East Asia.