Imagine I have a 2 stock portfolio, A & B, for which I pay £100 believing they’re each worth £150

A £200 portfolio with a fair value of £300 and a potential return of 50%

The next day, company A announces fabulous results and rallies 40% to a price of £140

Meanwhile, Company B’s competitor announces disappointing results and drags B down 20% to £80

Resulting in a portfolio worth £220 (140 + 80) with 36% upside to £300

My upside on A is only 7% – from £140 to £150

But for B it’s a juicier 88% – from £80 to £150

What should I do?

Surely you take £30 of profits on A and top up B to 50% of the portfolio (£110)

That re-balances your portfolio and lowers B’s average price to £94.55

Then start searching for another investment opportunity with a higher potential return than A’s paltry 7%

You’d think!

But there’s a problem

What?

I told my clients I’m a Buy and Hold Fund Manager and promised low turnover…

Why?

Most are fixated on low turnover because it’s conventional wisdom that high turnover reduces performance because of costs..

Oh don’t worry about those, most studies were conducted before brokerage rates collapsed

Besides, an excellent paper in 2012 by American Century Investments (see link in comments) concluded

“No relationship between portfolio turnover and performance”

and most importantly

“Using it to screen for asset managers could lead to the elimination of those with the potential to produce excess returns”

So don’t be a Level 1 thinker, especially regarding turnover

Quality-style funds should have lower turnover because the Quality of a company shouldn’t change massively from 1 quarter to the next (let’s ignore Estee Lauder, Adyen, and Dollar General for now shall we?)

BUT

Value funds SHOULD have higher turnover because absolute and relative Values are constantly changing, so why shouldn’t your positioning change accordingly?

Look at the peaks and troughs of the World index since the beginning of 2020. In only 4 years, the market

fell 33% then
rose 106% then
fell 29% then
rallied 33%

and this is a massively diversified index! Any individual company had much larger moves

Go check, but it wouldn’t surprise me if funds with low turnover under-performed over this period because each of those rallies and troughs revealed fantastic opportunities that simply sailed on by

But back to my 2 stock portfolio

Imagine if A and B BOTH rallied 40%

For a portfolio of £280 but worth £300

Would you invest?

Well historic performance would be an amazing +40%

So I’d be tempted, and know others would too

BUT

If the portfolio manager doesn’t rotate this £280 into new ideas with a fresh 50% upside,

all that’s left for me and others is the 7% to £300

Exactly!!

So as a new investor, you WANT turnover!

Besides, what are a few basis points of commission if you’re swapping 7% for 50% anyway?

Just remember, performance is net of all costs

including those relating to turnover