Portfolio churn is an important indicator to consider when assessing the quality of a fundamental long-term investor’s process.
Portfolio churn can be calculated as the value of sells (or buys) in a given year divided by the average value of the portfolio during the year. (Note: exclude hedging or cash-management transactions. Sometimes these trades can skew the actual churn in the underlying equity portfolio).
A high churn in the portfolio of a long-term fundamental investor should be viewed with caution. Successful long-term equity investing requires thorough analyses of investment positions. Once a position is sized and taken, it is important to let it season over a number of years to allow the investment thesis to unfold. Unless there is an extraordinary fundamental development in the position, it should not be disturbed.
There are many portfolios managed by professionals that have churns as high as 50 or 100%. A 100% churn implies that an entire portfolio is churned out in one year. Qualitatively, this implies a low conviction level of the fund manager in the portfolio companies, or someone that is just a closet momentum trader chasing the latest “rocket” stocks.
A number closer to 20% or below indicates a dependable process and strong conviction.