Portfolio turnover activity and mutual fund performance

We propose a new measure of portfolio activity, the Modified Turnover, which represents the portion of the portfolio that the manager changes from one quarter to the next. Compared with the traditional turnover, our Modified Turnover measure relies on portfolio holdings and takes into account the effects of offsetting trades and fund flows on portfolio turnover. We find evidence that high Modified Turnover predicts lower performance. The comparison between the highest and lowest quintiles sorted based on Modified Turnover reveals a difference of -2.41% in the annual risk-adjusted return. Furthermore, we find that high Modified Turnover predicts lower net flows and is impacted more by negative than positive net flows. We also find that Modified Turnover relates positively to other activeness measures while return, volatility, flows, size, number of stocks and the expense ratio are significant determinants of Modified Turnover. Overall our results suggest that frequent churning of a portfolio is value destroying for investors and signals a manager’s lack of skill.