Jack Bogle, the man credited with inventing index funds, foresees the growth in exchange traded funds (ETFs) slowing and “a lot of ETFs will go out of business along the way”.
Clearing up any confusion about interchangeability of these two investment products, the founder of Vanguard, which today has more than $5 trillion in assets under management, said traditional index funds (which he calls TIFs) and ETFs were “like night and day”.
Whilst index funds as a group have revolutionised how investors can cheaply and efficiently access the market, ETFs have been enabling a very different type of investor behaviour as opposed to TIFs.
In a recent interview with Barron’s, the respected American financial publication, Bogle agrees that it was the evolution of the index fund that created ETFs. But, he says, ETFs are the way passive indexing “morphs into active management” with its attendant problems, including increased transaction costs and market timing.
Intra-day liquidity, the ability to trade an ETF like a share, which is often touted as a major benefit of ETFs compared with TIFs, has encouraged just that – short-term trading in ETFs. Bogle points out alarming evidence of this overtrading in ETFs by looking at turnover: 785% in the 100 largest, versus 144% for the 100 largest stocks. He fears that ETFs are purely speculative, encouraging selling at the bottom and buying at the top.
Bogle, who counts Warren Buffett among his biggest fans, shared his analysis of dollar-weighted investor returns, which accounts for money flows, with Barron’s. The research confirms his fears by showing that from 2005 to 2017, the average investor return from TIFs was 8.4%; for actively managed funds, it was 7.2%; and for ETFs, it was 5.5% – even worse than actively managed funds.
Bogle’s research points to the poor investor behaviour, of speculative overtrading, that ETFs promote. Coupled with this overtrading is the associated cost of executing the many trades which can quietly add up without investors noticing, which is not applicable to TIFs.
The combination of speculative overtrading, or trying to time the market, with the associated costs means that over the long term, investors would have been better off in active funds as opposed to ETFs.
That, according to Bogle, contains the seeds of the ETF’s demise.
“How long are investors going to be happy with that?” he asks. “Sure if you double your money, why would you complain? But you could have tripled it.”
Bogle’s research confirms that TIFs are the clear winner and should be the vehicle of choice for long-term investors looking to efficiently and cheaply access the market.
He concluded: “I am glad we continue to be primarily on the TIF horse, and not the ETF horse.”
