Depending on how trigger-happy a fund’s manager is, trading costs can prove a formidable hurdle for returns to overcome. Trading costs are among the most opaque because they’re not reported as part of a fund’s expense ratio the same way that other costs of running the fund are. Funds must disclose the brokerage commissions they pay, but most times you have to hunt the disclosure down in a fund’s statement of additional information.
An imperfect proxy for high trading costs is high turnover in fund assets. A fund’s turnover ratio, which is readily available online or in a summary prospectus, tells you what percentage of a fund’s holdings have changed in a year’s time.
One look at the 506% turnover rate of Alpine Dynamic Dividend Fund (ADVDX) and you know it’s not your grandfather’s coupon-clipping dividend investment. The fund’s strategy is to buy a stock to capture the dividend, then sell and move on to the next. The tab for brokerage commissions in the fiscal year ended October 2010: $7.2 million, or 1.2% of assets, compared with about 0.30% for the average stock fund, according to Morningstar. And these figures don’t include the harmful impact of a fund’s trading on share prices, pushing them up when it buys and down when it sells.
Should high turnover cross a fund off your list? Not necessarily. But you need to be fully aware of it in order to decide whether or not you can live with it. Says S&P analyst Todd Rosenbluth: “All of these things -- not just the track record -- should be at the top of your mind when buying a fund.”