Skill and Turnover

Abstract

It is often argued that managed fund performance has not shown the ability to outperform acceptable investment benchmarks. Managers with relatively high turnover, reflecting their attempts to time the market or to emphasize the relative value of individual securities, are generally regarded as increasing costs with no direct investor benefit. In contrast, this article shows that, under reasonable assumptions regarding manager skill and transaction costs, increased turnover may result in, and be very necessary condition for, high levels of performance relative to the benchmark. In addition, an explicit relationship between skill, turnover, and return is established, and a manager performance ratio is developed that indicates how effectively turnover is utilized.