Research by Malvern, PA.- based Vanguard Group Inc. has confirmed that investors in exchange-traded funds (ETFs) are somewhat more active traders than mutual fund investors.
But Vanguard says the difference is largely because highly liquid ETFs are attracting those already inclined to trade frequently rather than tempting long-term investors to change their minds.
“Our research shows a higher level of trading among ETF investors, but still nothing even close to speculative behaviour,” says Joel Dickson, Vanguard’s senior ETF strategist. “ETFs are the preferred vehicle for traders, but ETFs don’t take someone who isn’t a trader and turn them into one.”
Questions have been raised in the investment industry as to whether the ability to trade ETF shares intraday is turning potential long-term investors into short-term traders. ETFs have always traded actively among large institutional investors; but with ETFs’ increasing popularity among retail investors, Vanguard, which sells both ETFs and mutual funds, decided to investigate the differences in investor behaviour pertaining to the two investment vehicles.
“There [are] concerns that because you can trade more frequently in ETFs, you will,” says Dickson. “And by doing so, you can harm yourself. Returns can be eaten away by the transaction costs incurred with a high level of trading. People also have shown themselves to be generally poor at market-timing, resulting in a loss of returns as they get in and out of their holdings at the wrong time.”
Vanguard scrutinized trading activity during the five-year period from 2007 through 2011, using both the mutual fund and ETF versions of four Vanguard portfolios: Vanguard Total Stock Market Index Fund, Vanguard Total Bond Market Index Fund, Vanguard Emerging Markets Stock Index Fund and Vanguard REIT Index Fund.
To facilitate analysis of the data, Vanguard assigned each ETF or mutual fund account to one of three categories: buy and hold; short-term; or hands-on. Vanguard’s research found that the majority of both mutual fund and ETF accounts were buy-and-hold investments; however, 83% of mutual funds accounts fell into that category, vs 62% for ETFs.
“Buy and hold” was defined by Vanguard as an investment held for more than one year, with no more than two “investment reversals” during any rolling one-year period. An “investment reversal” is a change in investment direction, such as the first buy after selling, or the first sell after buying. Vanguard considered two reversals to be a reasonable threshold because an investor engaging in normal rebalancing behaviour could easily experience two investment reversals in a year.
“Short-term” was defined as an investment held for less than one year. Mutual fund accounts made up 12% of this category, while ETFs accounted for 27%.
“Hands-on” referred to an investment held for more than one year but with more than two investment reversals during at least one rolling 12-month period. Only 5% of Vanguard mutual fund accounts were hands-on, compared with 12% of ETF accounts.
Investor behaviour may have been influenced by the fact that mutual fund investors at Vanguard cannot repurchase units in the same fund within two months of a sale, while ETFs have no such restrictions.
Although trading in ETFs was more active than for traditional mutual funds, the Vanguard study says more than 40% of the variation can be explained by differences in the demographic and account behavioural characteristics of mutual fund and ETF investors, and that not all of the higher level of activity can be attributed to the “temptation effect.”
“The ETF investment group,” Dickson says, “contained a higher number of older males, as well as people who log into their investment account daily. And these are the people who trade more frequently, whether it’s an ETF or a mutual fund.”
For example, the Vanguard study determined that 36% of the firm’s ETF investors check their accounts on a daily basis, compared with 16% for mutual funds. One of the largest determinants of investors’ tendency to trade their accounts actively is frequent checking of account values.
“A large part of trading habits depend on the makeup of the investor,” Dickson says. “Whether the underlying portfolio has an ETF wrapper around it or a mutual fund wrapper is not the primary determinant. It doesn’t change the investment DNA of the individual.”
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