The Inverse Relationship: Fund Performance And Its Turnover & Expense Ratio

1286 words - 6 pages

The Inverse Relationship: Fund Performance and its Turnover & Expense Ratio

Abstract
When investors are seeking diversified investment options with low initial investment requirements, many investors may find themselves delving into mutual funds. Often times, mutual funds can provide low cost, low maintenance options for everyday investors. The funds that an investor may choose are often professionally managed. The Prudential Jennison Health Sciences fund looks to offer investors a moderate return, with both a high turnover and expense ratio. Overall, this mutual fund does not seem like an ideal investment.

During this day and age, it might be safe to say that a majority of ...view middle of the document...

97). Those investors who are seeking a high return may very well be attracted to this fund as a solid investment option for their portfolio. Zacks Investment Research reports that this particular fund has returned almost fifty six percent over the last one year period (2014, p.1). Also, over a three year period, this mutual fund has had a return of over thirty six percent (Ghosh, p.1). According to Yahoo! Finance and Morning Star, this Prudential Jennison fund has a year-to-date return of 7.13 % compared to the health care industry year-to-date return of -1.05%. Currently, the mutual fund has an expense ratio of 1.18%, a 12b-1 fee of .30%, a front load charge of 5.50%, and a turnover of 54% (2014, Yahoo! Finance, p. 1).
Regardless of the investment choice, one of the first things that should be considered is the fees that may be associated with any given purchase. The fee structure of a mutual fund is very important, as it can affect the return that an investor may receive. In Mutual Fund Performance, the author clearly states his position on the importance of fee consideration when investing. He suggests that the expense ratio and an investor’s return are inversely related—the lower the expense ratio for a particular fund, the better results that will be gained by stockholders (Bogle, 2014, p. 14). Of course, the fees that are associated with an investment are not the determining factor, but are heavily weighted from a personal standpoint. The Prudential Jennison Health Sciences fund is a front load fund that also utilizes a 12b-1 fee structure, as well as a .75 % management fee. In essence, this fund will reduce an investor's return three times due to fees that other funds may not have.
Another metric to consider when determining whether to purchase a mutual fund is the manner in which the fund is managed. Bodie, Kane, & Marcus state that "the fraction of the portfolio that is 'replaced' each year" describes an investment's turnover measure (2014, p. 103). Essentially, if a mutual fund manager is actively managing the portfolio, he or she is purchasing and redeeming shares on a more frequent basis than one who is passively managing a fund. This active management will ultimately lead to a higher turnover ratio. A higher turnover ratio, coupled with a high expense ratio can adversely affect any gains that an investor might realize. In The Arithmetic of "All-In" Investment Expenses, author John Bogle suggests this higher turnover also presents an inverse relationship with performance. On page fifteen he states that a "high turnover is negatively correlated with fund performance" (2014). If one really thinks about this statement he or she should quickly begin to understand that a fund's performance and return may steadily diminish as its turnover increases. Given this, an investor...

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