Turnover Expense impact on Expense Ratio

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teacher
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Turnover Expense impact on Expense Ratio

Post by teacher » Sun Dec 14, 2014 10:48 am

While comparing target date 2030 funds for my son for his ROTH, I found the turnover ratio for the Vanguard fund is 7% while at Fidelity, it's 54%. I was wondering if a higher turnover ratio generates costs not reflected in a fund's expense ratio, so I found this on Investopedia: "A fund's trading activity, the buying and selling of portfolio securities, is not included in the calculation of the expense ratio." If that is the case, how can one tell what the turnover cost is? I always thought the expense ratio was all inclusive minus fees.

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Re: Turnover Expense impact on Expense Ratio

Post by crefwatch » Sun Dec 14, 2014 10:54 am

First, you should make sure you are comparing "like" funds. Are the target dates, for example, the same? Do they have roughly the same balance of stocks and bonds? A short-term bond fund, for example, has a high turnover ratio by definition. It's integral to the strategy of the fund.

You can, if you wish, download the Statement of Additional Information for a Mutual Fund. Using a word processor, (or if you're lucky, the Table of Contents) search for "Brokerage Expenses". In a narrative sentence (or very rarely, a table, which would be easier to find) you'll find the brokerage costs for the fund you're researching. Now you need a number like Average Net Assets for the SAME year as the expense ratio you have. You divide the Brokerage Expenses by the Average Net Assets, and that gives you the brokerage charges as if it were an Expense Ratio

Since the Average Net Assets is not required to be reported, you may have to approximate it by averaging the Net Assets for the first day and the last day of the reported year, which is in the Annual Report.

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Re: Turnover Expense impact on Expense Ratio

Post by dbr » Sun Dec 14, 2014 11:01 am

There was a recent thread asking almost exactly the same question. One poster put up some estimates of the cost impact. I think a possible estimate is 1% in costs for every 100% in turnover. As I recall that was the number for large cap funds in that post. Other asset classes were higher. My understanding is that bonds, as mentioned above, tend to turnover more rapidly but at much less cost.

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Re: Turnover Expense impact on Expense Ratio

Post by nisiprius » Sun Dec 14, 2014 11:54 am

One nice thing about an index fund is that you can pretty well bypass all such questions simply by looking at whether the fund is tracking its index, and how well.

For reasons I don't understand, all bond funds have huge turnover and I think someone explained to me why this isn't a problem, but I don't remember the explanation. So if the Vanguard fund were a stock fund and the Fidelity fund were a balanced fund, you'd see a difference.
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Re: Turnover Expense impact on Expense Ratio

Post by lazyday » Sun Dec 14, 2014 12:06 pm

dbr wrote:There was a recent thread asking almost exactly the same question.
Maybe you mean this one: viewtopic.php?f=10&t=151932&p=2278510#p2277176

The post above links to a study on turnover costs.

Also see http://www.bogleheads.org/wiki/Mutual_f ... onal_costs

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Re: Turnover Expense impact on Expense Ratio

Post by retiredjg » Sun Dec 14, 2014 12:17 pm

You are looking at the Fidelity Freedom Fund series - actively managed funds. If you want to compare like to like, compare to the Fidelity Freedom INDEX Fund series and be sure to find about the same stock to bond ratio regardless of the fund name.

But...I just looked it up on Morningstar and the turnover was 32%. Can't imagine why. I did not look at the Fidelity website to verify, but I would have though an index fund should not have that high a turnover.

I would NOT use the Fidelity Freedom series - just a jumbled unintelligible mess with a high expense ratio. I probably would use the Fidelity Freedom Index Series, but it is curious about that turnover.

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Re: Turnover Expense impact on Expense Ratio

Post by teacher » Sun Dec 14, 2014 12:31 pm

crefwatch wrote:
First, you should make sure you are comparing "like" funds. Are the target dates, for example, the same? Do they have roughly the same balance of stocks and bonds?
Vanguard Retirement 2030 Fund AA:
78.2 equities/24.06 fixed
US Stock 53.50%
Intl 21.65%
Bonds 22.53%
Cash 1.53%
Expense Ratio 0.17%
Turnover 7%

Fidelity Freedom 2030 fund AA:
83.87 equities/12.13 fixed
US Stock 57.55%
Intl 26.32%
Bonds 11.51%
Cash 3.98%
Other 0.64%
Expense Ratio .77%
Turnover 54%

A quick search found this:
Fidelity vs Vanguard 2014: Account Pricing, Commissions, Fees
http://www.brokerage-review.com/compare ... eview.aspx
However, I think this refers to brokerage costs outside of fund "trading activity, the buying and selling of portfolio securities".

dbr wrote:
I think a possible estimate is 1% in costs for every 100% in turnover.
That would be a massive addition to "low cost" funds.
In Fidelity's example .54% (turnover cost) added to .77% ER = 1.31% total expense ratio? :shock:
Vanguard total expense ratio is .24%?
Am I on the right page? If I am on the right track, turnover rate seems to be notable when choosing funds.

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Re: Turnover Expense impact on Expense Ratio

Post by dbr » Sun Dec 14, 2014 12:42 pm

teacher wrote: dbr wrote:
I think a possible estimate is 1% in costs for every 100% in turnover.
That would be a massive addition to "low cost" funds.
In Fidelity's example .54% (turnover cost) added to .77% ER = 1.31% total expense ratio? :shock:
Vanguard total expense ratio is .24%?
Am I on the right page? If I am on the right track, turnover rate seems to be notable when choosing funds.
There is still a big difference between stocks and bonds. The Vanguard total bond index has 73% turnover and the Vanguard total stock fund 4%. Bond fund costs are much less. A good part of the turnover is maturing bonds being replaced by new issues. I notice the Wiki article has a table but bond funds are not listed there. As mentioned before, you can consult fund annual reports including reports of supplementary information.

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Re: Turnover Expense impact on Expense Ratio

Post by teacher » Sun Dec 14, 2014 12:44 pm

retiredjg wrote:
If you want to compare like to like, compare to the Fidelity Freedom INDEX Fund series....I would NOT use the Fidelity Freedom series - just a jumbled unintelligible mess with a high expense ratio. I probably would use the Fidelity Freedom Index Series...
I'm so happy you caught that, jg. I assumed the Freedom fund was passive-managed and the target date was the same, so, I automatically assumed I was dealing with apples vs apples. Too much automatic assuming.
And dbr, thanks for the links, I was not able to find them with a quick search. Once again, you guys saved the day.

Back to the drawing board. I need to change my comparison chart replacing the Fidelity Freedom Fund with Fidelity Freedom Index Series.

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Re: Turnover Expense impact on Expense Ratio

Post by dbr » Sun Dec 14, 2014 12:48 pm

teacher wrote:retiredjg wrote:
If you want to compare like to like, compare to the Fidelity Freedom INDEX Fund series....I would NOT use the Fidelity Freedom series - just a jumbled unintelligible mess with a high expense ratio. I probably would use the Fidelity Freedom Index Series...
I'm so happy you caught that, jg. I assumed the Freedom fund was passive-managed and the target date was the same, so, I automatically assumed I was dealing with apples vs apples. Too much automatic assuming.
And dbr, thanks for the links, I was not able to find them with a quick search. Once again, you guys saved the day.

I think lazyday found the links in question. Thanks for that.

Back to the drawing board. I need to change my comparison chart replacing the Fidelity Freedom Fund with Fidelity Freedom Index Series.

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Re: Turnover Expense impact on Expense Ratio

Post by retiredjg » Sun Dec 14, 2014 1:18 pm

teacher wrote:I'm so happy you caught that, jg. I assumed the Freedom fund was passive-managed...
I don't think you are alone in this assumption. If you go to the Fidelity site and take a look at what is in those funds, you will be shocked. The Index version has be available in 401k plans for a few years, but only available to retail customers for a couple of months.

I'd vote for Vanguard, but I think Fido would be fine if that choice has a benefit.

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Re: Turnover Expense impact on Expense Ratio

Post by TradingPlaces » Sun Dec 14, 2014 1:51 pm

teacher wrote:While comparing target date 2030 funds for my son for his ROTH, I found the turnover ratio for the Vanguard fund is 7% while at Fidelity, it's 54%. I was wondering if a higher turnover ratio generates costs not reflected in a fund's expense ratio, so I found this on Investopedia: "A fund's trading activity, the buying and selling of portfolio securities, is not included in the calculation of the expense ratio." If that is the case, how can one tell what the turnover cost is? I always thought the expense ratio was all inclusive minus fees.
My opinions strictly:

- expense ratio is what fund manager charges for administration and management,
- if turnover is high, that should be reflected in the funds performance. A fund that trades more will make less returns.

E.g., imagine two target dates funds, with identical allocations. However, fund 1 rebalances quarterly, and fund 2 rebalances daily. Assuming that trading costs are roughly 3-4 bps on notional traded, and that the daily rebalancer has a 100% turnover vs the quarterly rebalancer, which has a 10% turnover, then the daily rebalancer will have a drag of about 3 bps per year.

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Re: Turnover Expense impact on Expense Ratio

Post by teacher » Sun Dec 14, 2014 1:53 pm

Oops. Thanks lazyday. I hesitate to ask for help finding links, so when someone supplies them, it's a gift.

Vanguard wins. Here's why:
The comparatively very low turnover rate at Vanguard (7% vs 32%) affects transaction costs and fund value as well. A fund’s turnover (trading activity, the buying and selling of securities) is not included in the calculation of the expense ratio. Total Fidelity Freedom Index 2030 FXIFX expense is .32 (turnover) +.16 (ER)=.48% Total ER vs .24% Total ER for Vanguard Target Retirement 2030 Fund (VTHRX). Figure it this way — for each $10,000 invested in the Fidelity 2030 fund, you are paying an extra $24 per year in fund expenses to Fidelity than you would be paying at Vanguard.

Also, for my newbie-investor son:
Fidelity has an annual $25 account fee. Vanguard's annual account service fee is $20 per fund with for a balance of less than $10,000 is waived if you sign up for electronic delivery for fund reports.
Fidelity will assess a $12 annual “low balance” charge if your account value or each fund drops below $2,500, and Fidelity charges a $50 account closeout fee per fund in a retirement account. By contrast, Vanguard does not have a "low balance" charge and does not charge account closing fees.

On the face of it, Fidelity's .16 ER vs Vanguard's .17 ER can be deceiving when not considering turnover rate. Looking in the rear view mirror, Vanguard 2030 outperforms the past three years, but YTD, Fidelity is up 2.29%. Interesting, I consider costs more important that recent performance. I could be wrong, but my gut tells me the former is more predictable than the latter.
Last edited by teacher on Sun Dec 14, 2014 1:56 pm, edited 1 time in total.

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Re: Turnover Expense impact on Expense Ratio

Post by TradingPlaces » Sun Dec 14, 2014 1:55 pm

dbr wrote:There was a recent thread asking almost exactly the same question. One poster put up some estimates of the cost impact. I think a possible estimate is 1% in costs for every 100% in turnover. As I recall that was the number for large cap funds in that post. Other asset classes were higher. My understanding is that bonds, as mentioned above, tend to turnover more rapidly but at much less cost.

I think 1% is too much. 5bps in costs for 100% turnover, for stocks, is a good estimate. For bonds, it is even less. And lastly, if you are dealing with short term bonds, a lot of the turnover is due to bonds maturing, and that might not result in that much costs.

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Re: Turnover Expense impact on Expense Ratio

Post by teacher » Sun Dec 14, 2014 2:02 pm

TradingPlaces wrote:
My opinions strictly:
- expense ratio is what fund manager charges for administration and management,
- if turnover is high, that should be reflected in the funds performance. A fund that trades more will make less returns.
That is exactly what I thought before I found the comment from Investopedia regarding Expense Ratio:
"A fund's trading activity, the buying and selling of portfolio securities, is not included in the calculation of the expense ratio."
Perhaps there is complexity I am not able to fathom.

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Re: Turnover Expense impact on Expense Ratio

Post by dbr » Sun Dec 14, 2014 2:17 pm

teacher wrote:TradingPlaces wrote:
My opinions strictly:
- expense ratio is what fund manager charges for administration and management,
- if turnover is high, that should be reflected in the funds performance. A fund that trades more will make less returns.
That is exactly what I thought before I found the comment from Investopedia regarding Expense Ratio:
"A fund's trading activity, the buying and selling of portfolio securities, is not included in the calculation of the expense ratio."
Perhaps there is complexity I am not able to fathom.
The fund performance is gross performance less expenses. Part of the expenses are reported in the ER and part of them are not. When you look at the fund NAV, that is the result after all expenses, so you see what you get. ER expenses plus the not reported other expenses would be the difference between the actual NAV and the hypothetical performance of the investment portfolio if there were a way to own it without expenses. If two funds that hold the same investments, or at least try to, are different in performance the cause could be tracking error, meaning they don't actually hold what was intended, and the the cause could be different total costs, ER and other costs added together.

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Re: Turnover Expense impact on Expense Ratio

Post by teacher » Sun Dec 14, 2014 2:30 pm

Thanks, dbr!
This is a revelation for me. But it reminds me of a quote:
“The more I learn, the more I realize how much I don't know.”
Albert Einstein

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Re: Turnover Expense impact on Expense Ratio

Post by beammeupscotty » Sun Dec 14, 2014 2:59 pm

This appears to be another area where index funds have a big advantage. I was recently looking more closely into Vanguard International Explorer vs. Vanguard FTSE All-World ex-US Small-Cap Index. Not only does the active fund have a higher expense ratio (0.36% vs. 0.20% for the ETF), but the brokerage commissions (available in the Statement of Additional Information) incurred were much higher as well. While they have the same amount of assets ($2.5 billion), the active fund had $2.3 million in brokerage commissions in 2013, while the index fund's commissions were $115,000, a 20:1 ratio. That works out to an additional cost of 0.09% for the active fund vs. 0.0046% for the index.

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Re: Turnover Expense impact on Expense Ratio

Post by dbr » Sun Dec 14, 2014 3:01 pm

Then there is a final cost in taxable accounts which is that active funds will incur higher taxable distributions of capital gains.

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Re: Turnover Expense impact on Expense Ratio

Post by JoMoney » Sun Dec 14, 2014 3:31 pm

Trading / Brokerage fees are not a part of the Expense Ratio.
Such fees are generally listed in the the mutual funds SAI "Statement of Additional Information" (sometimes found attached to/with the prospectus). The amount spent on trading fees is usually listed as a dollar amount, so to figure what the proportionate cost is you also need to know what the funds total net assets were and divide it by that. The funds net assets can usually be found in the annual report (but may be available elsewhere).
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Re: Turnover Expense impact on Expense Ratio

Post by bertilak » Sun Dec 14, 2014 3:44 pm

nisiprius wrote:For reasons I don't understand, all bond funds have huge turnover and I think someone explained to me why this isn't a problem, but I don't remember the explanation.
I believe that it is because bond funds hold so many bonds that many of the bonds will mature on a daily basis. They will need to be replaced.

(I believe the funds actually sell bonds a bit early. Not sure why. Perhaps it simplifies things in some way.)

Stocks don't mature so no need for selling/buying to keep up with the market.
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Re: Turnover Expense impact on Expense Ratio

Post by Doc » Sun Dec 14, 2014 7:05 pm

nisiprius wrote:One nice thing about an index fund is that you can pretty well bypass all such questions simply by looking at whether the fund is tracking its index, and how well.
Yeh, that's what it says in the book but:

SPDR S&P International Small Cap ETF GWX had a turnover of some 50% for the year 2014 fiscal year. :(
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Re: Turnover Expense impact on Expense Ratio

Post by Doc » Sun Dec 14, 2014 7:12 pm

Regarding bond funds:

I think derivatives also can add to the reported high turnover in bond funds. A 30 day interest rate swap gives you a turn over of x12. And an overnight investment of cash of 1% of your portfolio is what 360% turnover for 1% of your portfolio which alone adds 3.6% to the total fund turnover. (I probably slipped a decimal point somewhere but the idea is sound - I think.)
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