Jon Chevreau recently blogged (see John Bogle says investors getting killed by ETFs) on John Bogle’s analysis of returns experienced by investors in Exchange-Traded Funds (ETFs) and the results are not pretty: In 68 out of 79 ETFs, the returns experienced by investors lagged that of the ETFs themselves by an average of 4.5%. Bogle also found that investors in ETFs did much worse than investors in index mutual funds. In some categories such as large-cap stocks and small-cap stocks, the gap was particularly large — more than 7%. And the shortfall was as much as 12% in REITs! These results mirror that of the famed DALBAR study, which consistently finds mutual fund investors earning lower returns than the funds themselves (see Investors Behaving Badly).
I think the comparison of index mutual fund investors to those of ETFs is a bit simplistic. Unlike mutual funds, which are purchased by retail investors with the intention of holding for the long-term, the motivation for buying ETFs varies according to the type of investor. Some are passive investors who intend to hold ETFs in an indexed portfolio for the long-term. But most ETF buyers and sellers are traders who hope to profit from short-term movements. The popularity of ETFs with traders can be seen in the contrast in volume between Vanguard and iShares ETFs that track the same index. Despite charging less than half in fees, Vanguard ETFs such as the Emerging Markets ETF (VWO) and Europe Pacific ETF (VEA) have much lower trading volume than their corresponding iShares ETFs. Long-term investors would care more about the lower fees but traders would be primarily concerned with liquidity and low bid/ask spreads, not a MER difference of a few tenths of a basis point. Therefore, it shouldn’t be entirely surprising that, as a group, the returns from trading badly trail the overall market.
