"ETFs Are 'Weapons of Mass Destruction'"

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"ETFs Are 'Weapons of Mass Destruction'"

Post by baw703916 » Thu Apr 27, 2017 11:24 am

I got a good chuckle out of this article which appeared on Bloomberg this morning:
Exchange-traded funds are “weapons of mass destruction” that have distorted stock prices and created the potential for a market selloff, according to the managers of the FPA Capital Fund.

“When the world decides that there is no need for fundamental research and investors can just blindly purchase index funds and ETFs without any regard to valuation, we say the time to be fearful is now,” Arik Ahitov and Dennis Bryan, who run the $789 million fund, said in an April 6 letter to investors.
So, if you're like me and had never heard of FPA Capital Fund, here's a little background:
For more than two decades under former manager Robert Rodriguez, Los Angeles-based FPA Capital was among the top-performing stock funds in the U.S. From 1986 to 2010, it returned 14.5 percent a year compared to 8.5 percent for the Russell 2000 Index, according to a data compiled by Bloomberg.

The fund has struggled in recent years, in part, because the managers, finding too few attractive stocks to buy, have parked 35 percent of their money in cash. FPA Capital trailed 99 percent of peers over the past five years...
Vanguard has, predictably, a different take on passive investing:
But Jim Rowley, senior investment strategist at Vanguard Group, disagrees with the naysayers. Vanguard, which has roughly $3 trillion in assets in passive products, including almost $700 billion in ETFs, has examined more than 20 years of market history, he said. The conclusion: markets are as volatile as ever and the dispersion in the performance of individual stocks is as great as it was before indexing became popular.

“We didn’t find any relationship between indexing and market dynamics,” he said.
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Re: "ETFs Are 'Weapons of Mass Destruction'"

Post by willthrill81 » Thu Apr 27, 2017 11:28 am

Translation: The low-cost ETFs (and index funds) out there are weapons of THEIR mass destruction. :D
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Re: "ETFs Are 'Weapons of Mass Destruction'"

Post by goingup » Thu Apr 27, 2017 11:35 am

Well Jack Bogle did once compare the ETF to the Purdy shotgun--excellent for big-game hunting and terrific for suicide. But that was an entirely different context and an admonition about the ease of trading them.

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Re: "ETFs Are 'Weapons of Mass Destruction'"

Post by oldcomputerguy » Thu Apr 27, 2017 11:35 am

Well, I don't find it surprising that they would come out against index investing. Vanguard's Midcap Value Admiral Share fund Has outperformed FPA Capital Fund consistently, solidly thrashing it over the last 3-year and 5-year periods.

My heart bleeds purple peanut butter for FPA Capital.
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Re: "ETFs Are 'Weapons of Mass Destruction'"

Post by livesoft » Thu Apr 27, 2017 11:38 am

So why didn't FPA capital park 35% of their money into ETFs instead of cash?

The market does have some fundamental characteristics, but a lot of it is a beauty contest.
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Re: "ETFs Are 'Weapons of Mass Destruction'"

Post by lack_ey » Thu Apr 27, 2017 12:43 pm

Yeah, FPA is known for being pretty contrarian and rather unconvinced by current asset pricing. When your market timing has been that wrong for that long, of course you blame others for all their irrationality. It's not your fault, right? (Of course, they've had plenty of success in the past as well so it's not all bad.)

As another example their only fixed-income fund has had an annualized standard deviation of 1% (for reference, compared to total bond's 3.7%) the last 10 years because they've really been hugging the short end of the yield curve. That said, they've been in the right parts of the market to do better than you'd expect given all the hiding under the covers.

The substance of the points and the arguments don't really seem to follow logically or empirically so there's not much to say there.

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Re: "ETFs Are 'Weapons of Mass Destruction'"

Post by wolf359 » Thu Apr 27, 2017 12:51 pm

I don't know, TNA is looking mighty good lately.

TNA is the Direxion Daily Small Cap Bull 3X ETF. The idea is that it is leveraged so that whatever small caps did that day got magnified by 300%.

Its 52 week high is 115, and its 52 week low is 52.71. It's designed for day trading. :|

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Re: "ETFs Are 'Weapons of Mass Destruction'"

Post by willthrill81 » Thu Apr 27, 2017 12:59 pm

wolf359 wrote:I don't know, TNA is looking mighty good lately.

TNA is the Direxion Daily Small Cap Bull 3X ETF. The idea is that it is leveraged so that whatever small caps did that day got magnified by 300%.

Its 52 week high is 115, and its 52 week low is 52.71. It's designed for day trading. :|
An ER of .95%? Wow that's high, but I suppose that's the price you pay for leverage.

I suppose that if it was a SCV ETF that you could theoretically hold it in lieu of an un-leveraged SCV ETF and hold a correspondingly higher percentage of fixed income to potentially reduce volatility, though it might be offset by that high ER.

So with something like a LP, you could hold 90% ITT and 5% each of a 3x leveraged SCV and international SC ETF.
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Re: "ETFs Are 'Weapons of Mass Destruction'"

Post by wolf359 » Thu Apr 27, 2017 1:05 pm

willthrill81 wrote:
wolf359 wrote:I don't know, TNA is looking mighty good lately.

TNA is the Direxion Daily Small Cap Bull 3X ETF. The idea is that it is leveraged so that whatever small caps did that day got magnified by 300%.

Its 52 week high is 115, and its 52 week low is 52.71. It's designed for day trading. :|
An ER of .95%? Wow that's high, but I suppose that's the price you pay for leverage.

I suppose that if it was a SCV ETF that you could theoretically hold it in lieu of an un-leveraged SCV ETF and hold a correspondingly higher percentage of fixed income to potentially reduce volatility, though it might be offset by that high ER.

So with something like a LP, you could hold 90% ITT and 5% each of a 3x leveraged SCV and international SC ETF.
Nope, designed for day trading means it only works well for a holding period of one day. It's supposed to triple if the small caps go up. If small caps go down instead, it's a little unpredictable. Maybe it will go down by 300%. Maybe it will be more, maybe less. It really isn't designed for buy-and-hold. It also doesn't always work correctly.

When I hear the phrase "ETFs are Weapons of Mass Destruction," this is the ETF I think of. It's chart looks pretty normal (if a bit volatile) until you look at the numbers and realize what percentage moves it is making.

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Re: "ETFs Are 'Weapons of Mass Destruction'"

Post by willthrill81 » Thu Apr 27, 2017 1:10 pm

wolf359 wrote:Nope, designed for day trading means it only works well for a holding period of one day.
That doesn't mean that it couldn't be potentially useful to buy-and-hold investors. The leveraging is just done for you.
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Re: "ETFs Are 'Weapons of Mass Destruction'"

Post by Levett » Thu Apr 27, 2017 1:15 pm


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Re: "ETFs Are 'Weapons of Mass Destruction'"

Post by wolf359 » Thu Apr 27, 2017 1:18 pm

willthrill81 wrote:
wolf359 wrote:Nope, designed for day trading means it only works well for a holding period of one day.
That doesn't mean that it couldn't be potentially useful to buy-and-hold investors. The leveraging is just done for you.
It's not that easy. This is from FINRA.

Source: http://www.finra.org/investors/alerts/l ... -investors
The following two real-life examples illustrate how returns on a leveraged or inverse ETF over longer periods can differ significantly from the performance (or inverse of the performance) of their underlying index or benchmark during the same period of time.

Between December 1, 2008, and April 30, 2009, a particular index gained 2 percent. However, a leveraged ETF seeking to deliver twice that index's daily return fell by 6 percent—and an inverse ETF seeking to deliver twice the inverse of the index's daily return fell by 26 percent.

During that same period, an ETF seeking to deliver three times the daily return of a different index fell 53 percent, while the underlying index actually gained around 8 percent. An ETF seeking to deliver three times the inverse of the index's daily return declined by 90 percent over the same period.

How can this apparent breakdown between longer term index returns and ETF returns happen? Here’s a hypothetical example: let’s say that on Day 1, an index starts with a value of 100 and a leveraged ETF that seeks to double the return of the index starts at $100. If the index drops by 10 points on Day 1, it has a 10 percent loss and a resulting value of 90. Assuming it achieved its stated objective, the leveraged ETF would therefore drop 20 percent on that day and have an ending value of $80. On Day 2, if the index rises 10 percent, the index value increases to 99. For the ETF, its value for Day 2 would rise by 20 percent, which means the ETF would have a value of $96. On both days, the leveraged ETF did exactly what it was supposed to do—it produced daily returns that were two times the daily index returns. But let’s look at the results over the 2 day period: the index lost 1 percent (it fell from 100 to 99) while the 2x leveraged ETF lost 4 percent (it fell from $100 to $96). That means that over the two day period, the ETF's negative returns were 4 times as much as the two-day return of the index instead of 2 times the return.
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Re: "ETFs Are 'Weapons of Mass Destruction'"

Post by ACM4297 » Thu Apr 27, 2017 1:23 pm

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Re: "ETFs Are 'Weapons of Mass Destruction'"

Post by CantPassAgain » Thu Apr 27, 2017 2:00 pm

Is their problem ETFs or index investing? There are plenty of managed ETFs as well.

It seems like lots of folks are saying "ETF" as a catch all term for certain things these days.

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Re: "ETFs Are 'Weapons of Mass Destruction'"

Post by Longtermgrowth » Thu Apr 27, 2017 2:34 pm

I think of the popular total market indexed ETFs as weapons of mass destruction to all the sales persons attempting to mask themselves as "financial advisors"; who are only out to make as much as possible off unsuspecting customers, even if their pitches may not fit into any type of suitability category that they should minimally, in some cases.

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Re: "ETFs Are 'Weapons of Mass Destruction'"

Post by Tamalak » Thu Apr 27, 2017 2:52 pm

Index investors neither Bid nor Ask, they merely buy blindly at market price. All that is set by active investors. So in EVERY trade, someone is setting a price, a valuation. Passive does not trade with passive, so no trade is actually passive in total.

If indexing started to get 'out of control' we'd see nasty Bid-Ask spreads, and poor liquidity - investing a bunch of your money would appreciably move stock prices. This problem would instantly be taken care of by profit seekers.

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Re: "ETFs Are 'Weapons of Mass Destruction'"

Post by JoMoney » Thu Apr 27, 2017 3:57 pm

ACM4297 wrote:This argument has never made any sense to me. If anything, as more people passively index, the potential to gain from active management increases because there are fewer active agents keeping the market efficient...
Or maybe it's the other way around, with fewer active agents trading, the market is more efficient with fewer 'suckers' for them to have an advantage trading against.
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Re: "ETFs Are 'Weapons of Mass Destruction'"

Post by afan » Thu Apr 27, 2017 4:34 pm

Well, we individual index investors buy blindly. But those who run index funds do all they can to shave fractions of pennies off their but prices. They are zero information traders in terms of predicting sto k prices, but they use sophisticated approaches to avoid paying too much to match the index.

Of course, as zero information traders, they should be easy pickings for the great active traders at FPA. Maybe they hold a lot of cash so they can take advantage of index funds?? How has that been working out?
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Re: "ETFs Are 'Weapons of Mass Destruction'"

Post by wolf359 » Thu Apr 27, 2017 5:41 pm

afan wrote:Well, we individual index investors buy blindly. But those who run index funds do all they can to shave fractions of pennies off their but prices. They are zero information traders in terms of predicting sto k prices, but they use sophisticated approaches to avoid paying too much to match the index.

Of course, as zero information traders, they should be easy pickings for the great active traders at FPA. Maybe they hold a lot of cash so they can take advantage of index funds?? How has that been working out?
Index Front Running
Index funds, which have enjoyed many years of outperformance at the expense of active traders, have become their targets for another type of front running. Index funds generally try to track an index by mirroring its portfolio. Because the index changes its composition of stocks periodically, traders can anticipate when an index fund is going to update its portfolio, and step in front of the trade. For example, in 2015, American Airlines Group Inc. was added to the Standard & Poor’s 500 index (S&P 500 index). The minute the addition was announced four days earlier, HFT traders were able to start buying up shares in advance of the rest of the market and benefited from an 11% gain by the time it was actually added to the index.


Source: Front Running http://www.investopedia.com/terms/f/fro ... z4fUaewUP3

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Re: "ETFs Are 'Weapons of Mass Destruction'"

Post by afan » Thu Apr 27, 2017 5:50 pm

Good reason to buy the total stock market, rather than a subset.

Kind of depressing that, given the large amount of money in the S&P500 and this widely known maneuver, active traders STILL lag the indexes. Even with this periodic head start, their stock picking, expenses and fees leave them trailing the market.

What is remarkable is how little even limited indexes like the S&P500 lose to active investors. Index funds do NOT simply immediately buy and sell to match the index. They also use futures and options to produce a portfolio with R squared and beta of 1.00 but need not always have perfect replication.
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Re: "ETFs Are 'Weapons of Mass Destruction'"

Post by willthrill81 » Thu Apr 27, 2017 6:00 pm

afan wrote:Good reason to buy the total stock market, rather than a subset.
I don't follow that logic. Are you saying that it's a mistake to tilt a portfolio toward small, for instance? Many of us do this with indexes.
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Re: "ETFs Are 'Weapons of Mass Destruction'"

Post by CantPassAgain » Thu Apr 27, 2017 6:18 pm

willthrill81 wrote:
afan wrote:Good reason to buy the total stock market, rather than a subset.
I don't follow that logic. Are you saying that it's a mistake to tilt a portfolio toward small, for instance? Many of us do this with indexes.
Mistake? Maybe, maybe not. But you will lose a "smidgeon" of return to front running of the indexes.

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Re: "ETFs Are 'Weapons of Mass Destruction'"

Post by willthrill81 » Thu Apr 27, 2017 6:20 pm

CantPassAgain wrote:
willthrill81 wrote:
afan wrote:Good reason to buy the total stock market, rather than a subset.
I don't follow that logic. Are you saying that it's a mistake to tilt a portfolio toward small, for instance? Many of us do this with indexes.
Mistake? Maybe, maybe not. But you will lose a "smidgeon" of return to front running of the indexes.
Not if you own the index. There are small cap indexes, small cap value, small cap growth, large cap value, etc. The TSM is not the only index out there.
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Re: "ETFs Are 'Weapons of Mass Destruction'"

Post by CantPassAgain » Thu Apr 27, 2017 6:27 pm

willthrill81 wrote:
CantPassAgain wrote:
willthrill81 wrote:
afan wrote:Good reason to buy the total stock market, rather than a subset.
I don't follow that logic. Are you saying that it's a mistake to tilt a portfolio toward small, for instance? Many of us do this with indexes.
Mistake? Maybe, maybe not. But you will lose a "smidgeon" of return to front running of the indexes.
Not if you own the index. There are small cap indexes, small cap value, small cap growth, large cap value, etc. The TSM is not the only index out there.
Maybe if you own every index that makes up the total stock market, just as separate funds...I took his comment to mean it's better to own the total stock market as opposed to only the 500 index.

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Re: "ETFs Are 'Weapons of Mass Destruction'"

Post by triceratop » Thu Apr 27, 2017 6:38 pm

CantPassAgain wrote:
willthrill81 wrote:
CantPassAgain wrote:
willthrill81 wrote:
afan wrote:Good reason to buy the total stock market, rather than a subset.
I don't follow that logic. Are you saying that it's a mistake to tilt a portfolio toward small, for instance? Many of us do this with indexes.
Mistake? Maybe, maybe not. But you will lose a "smidgeon" of return to front running of the indexes.
Not if you own the index. There are small cap indexes, small cap value, small cap growth, large cap value, etc. The TSM is not the only index out there.
Maybe if you own every index that makes up the total stock market, just as separate funds...I took his comment to mean it's better to own the total stock market as opposed to only the 500 index.
The point is simple: Front-running occurs when a stock moves into or out of an index in a predictable way such that the mutual fund buys or sells after the active people in the market act on that change. If the index is the entire market, what stocks are moving in and out of the market? just the micro-caps and new IPOs. And Vanguard only samples the micro-caps, so front-running is challenging there.
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Re: "ETFs Are 'Weapons of Mass Destruction'"

Post by baw703916 » Thu Apr 27, 2017 6:53 pm

The R2000 was pretty notorious for front running--I think they've now changed the construction to minimize it.

Basically, in the Olde Days, it was stocks 1001-3000 by market cap as of a certain date. It was reconstituted once a year, and everybody knew when that would happen. So you just had to see what stocks would be added or removed. Heck, if you were a hedge fund with enough capital, you could just bid up the price to put them in the index yourself!
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Re: "ETFs Are 'Weapons of Mass Destruction'"

Post by ACM4297 » Thu Apr 27, 2017 9:41 pm

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Re: "ETFs Are 'Weapons of Mass Destruction'"

Post by lack_ey » Thu Apr 27, 2017 11:02 pm

ACM4297 wrote:
JoMoney wrote:
ACM4297 wrote:This argument has never made any sense to me. If anything, as more people passively index, the potential to gain from active management increases because there are fewer active agents keeping the market efficient...
Or maybe it's the other way around, with fewer active agents trading, the market is more efficient with fewer 'suckers' for them to have an advantage trading against.
I'm rather sure this is not true, but I'll be sure to post my paper when it's finished (probably a few months out as I have the theory worked out, but still need to code the simulations). A simple argument by contradiction goes as follows: if there is no law of diminishing returns, Sharpe tells us there is no rational reason to actively manage. If there is no rational reason to actively manage, everyone should index. If everyone indexes, there is no trading and no market. With no market, where are we? The market always requires at least a few people to make the market, and handsomely rewards the market makers with the bid-ask spread differential of their choosing. Hopefully my hypothesis is right, but I'll be sure to share my paper either way.
How does that address the issue of investors on the fringes switching to indexing?

In the current state you still have a whole lot of active management, market makers, etc. You're just replacing certain trading activity with the lower-volume and generally lower-market-impact trading activity of index-based fund management.

Not all trading makes the market more efficient. If your trades are pushing prices to be less correct and you reduce your trading activity, you're leaving fewer mispricings for others to exploit. On average it's going to be the lower-skilled participants who are more likely to switch towards indexing.

I don't know the actual impact, but under what kind of assumptions do you reach the opposite conclusion?


With respect to aggregate market behavior, looking beyond the Sharpe "arithmetic of active management" and considering a non-static market, see for example "Sharpening the Arithmetic of Active Management" and a couple posts from philosophicaleconomics. These don't answer the question here of the effect of just some people switching to indexing.

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Re: "ETFs Are 'Weapons of Mass Destruction'"

Post by JoMoney » Fri Apr 28, 2017 3:02 am

ACM4297 wrote:
JoMoney wrote:
ACM4297 wrote:This argument has never made any sense to me. If anything, as more people passively index, the potential to gain from active management increases because there are fewer active agents keeping the market efficient...
Or maybe it's the other way around, with fewer active agents trading, the market is more efficient with fewer 'suckers' for them to have an advantage trading against.
I'm rather sure this is not true, but I'll be sure to post my paper when it's finished (probably a few months out as I have the theory worked out, but still need to code the simulations). A simple argument by contradiction goes as follows: if there is no law of diminishing returns, Sharpe tells us there is no rational reason to actively manage. If there is no rational reason to actively manage, everyone should index. If everyone indexes, there is no trading and no market. With no market, where are we? The market always requires at least a few people to make the market, and handsomely rewards the market makers with the bid-ask spread differential of their choosing. Hopefully my hypothesis is right, but I'll be sure to share my paper either way.
Sharpe doesn't show there's no rational reason to actively manage, just that it's a zero sum game. The only way for one portfolio to garner above average performance is for another to have below average performance. If you're a believer that the market is "efficient" then it's just a matter of luck or maybe an exchange of risk preferences for risk premiums. If you believe there may be skill or asymmetric information in the market then unless you're the one with that advantage, every time you trade you're at a disadvantage and the (I think obvious) strategy is to not trade or at least minimize trading to limit your exposure to it.
I'm not sure to what extent I believe having 'know nothing' investors trading in the market increases or decreases efficiency, my assumption is that it does move like a pendulum sometimes with more efficiency sometimes less.
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Re: "ETFs Are 'Weapons of Mass Destruction'"

Post by AlohaJoe » Fri Apr 28, 2017 3:54 am

goingup wrote:Well Jack Bogle did once compare the ETF to the Purdy shotgun--excellent for big-game hunting and terrific for suicide. But that was an entirely different context and an admonition about the ease of trading them.
Recent research has shown that Bogle's theoretical fears were unfounded and people who own ETFs are no more likely to trade them than people who own mutual funds.

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Re: "ETFs Are 'Weapons of Mass Destruction'"

Post by nisiprius » Fri Apr 28, 2017 6:54 am

AlohaJoe wrote:
goingup wrote:Well Jack Bogle did once compare the ETF to the Purdy shotgun--excellent for big-game hunting and terrific for suicide. But that was an entirely different context and an admonition about the ease of trading them.
Recent research has shown that Bogle's theoretical fears were unfounded and people who own ETFs are no more likely to trade them than people who own mutual funds.
Source?
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Re: "ETFs Are 'Weapons of Mass Destruction'"

Post by Call_Me_Op » Fri Apr 28, 2017 7:33 am

willthrill81 wrote:Translation: The low-cost ETFs (and index funds) out there are weapons of THEIR mass destruction. :D
Indeed.
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Re: "ETFs Are 'Weapons of Mass Destruction'"

Post by JoMoney » Fri Apr 28, 2017 8:42 am

nisiprius wrote:
AlohaJoe wrote:
goingup wrote:Well Jack Bogle did once compare the ETF to the Purdy shotgun--excellent for big-game hunting and terrific for suicide. But that was an entirely different context and an admonition about the ease of trading them.
Recent research has shown that Bogle's theoretical fears were unfounded and people who own ETFs are no more likely to trade them than people who own mutual funds.
Source?
Vanguard has a study, that does show ETFs are more frequently traded, but discounts it as being individuals who want to trade choose ETFs, not that ETFs "tempt" otherwise buy and hold investors into trading
https://personal.vanguard.com/pdf/s318.pdf
... Nonetheless, a substantial difference in trading activity between our mutual fund investments and ETF investments does exist. As Figure 1 showed, although the majority of investments in both share classes exhibit buy-and-hold behavior, a smaller proportion of our ETF investments (relative to mutual funds) lie in the buy-and-hold category and a greater proportion are classified as short-term or hands-on. ...

... We found that, contrary to speculations in the popular media, most investments are held in a prudent, buy-and-hold manner, regardless of share class. Although behavior in ETFs is more active than behavior in traditional mutual funds, some of that difference is simply due to the fact that investors who are inclined to trade choose ETFs, not that investors who choose ETFs are induced to trade...
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Re: "ETFs Are 'Weapons of Mass Destruction'"

Post by nisiprius » Fri Apr 28, 2017 9:11 am

JoMoney wrote:...Vanguard has a study, that does show ETFs are more frequently traded, but discounts it as being individuals who want to trade choose ETFs, not that ETFs "tempt" otherwise buy and hold investors into trading...
It's not an easy question to answer. I remember my amazement at realizing that the combination of web access, a tax-advantaged account, and the general practice of zero fees for exchanges within the same fund family, meant that I could trade to my heart's content with zero commission and zero tax consequences. I imagine that's a more powerful temptation to trade than ETF-versus-mutual fund. Even with the 30-day frequent-trading rule.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

MisterBill
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Re: "ETFs Are 'Weapons of Mass Destruction'"

Post by MisterBill » Fri Apr 28, 2017 12:58 pm

willthrill81 wrote:Translation: The low-cost ETFs (and index funds) out there are weapons of THEIR mass destruction. :D
Well, if you look at their annual report, their assets dropped by $300m between 2015 and 2016 --

http://quote.morningstar.com/fund-filin ... d3911a4afd

I wonder what they were at their peak?

afan
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Re: "ETFs Are 'Weapons of Mass Destruction'"

Post by afan » Fri Apr 28, 2017 1:04 pm

nisiprius wrote:
JoMoney wrote:...Vanguard has a study, that does show ETFs are more frequently traded, but discounts it as being individuals who want to trade choose ETFs, not that ETFs "tempt" otherwise buy and hold investors into trading...
It's not an easy question to answer. I remember my amazement at realizing that the combination of web access, a tax-advantaged account, and the general practice of zero fees for exchanges within the same fund family, meant that I could trade to my heart's content with zero commission and zero tax consequences. I imagine that's a more powerful temptation to trade than ETF-versus-mutual fund. Even with the 30-day frequent-trading rule.
Low cost to trade, yes. But if one expects to accomplish nothing then there is still no temptation to do it.
We don't know how to beat the market on a risk-adjusted basis, and we don't know anyone that does know either | --Swedroe | We assume that markets are efficient, that prices are right | --Fama

afan
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Re: "ETFs Are 'Weapons of Mass Destruction'"

Post by afan » Fri Apr 28, 2017 1:30 pm

If everyone indexes, there is no trading and no market.

Well, no.

I index, but I trade every time a paycheck comes in. Every time a dividend is reinvested. When I get paid for my side job. It is always total stock market, but I trade. I only buy, since I am in the accumulation phase.

Plenty of people and companies sell for inverse reason. Retirees have to take distributions from retirement funds. They may need to liquidate to pay for their expenses. People of all ages sell stock to invest in something else, like a house. Businesses may finance expansion in part with stock sales. Both may sell to pay taxes or other costs.


Now you have indexers selling and indexers buying. Plenty of trading, but no active management.

People who are compensated in company stock have to sell it, trade, in order to buy total stock market, trading again. They may be purely passive, but their compensation scheme forces them to regularly trade to maintain their passive portfolios.

None of this has anything to do with attempting to predict prices of individual stocks or the entire market.

It is hardly true that a market in which all investors index would have no trading. If they all used the same total stock market proxy, then the only thing that would trade would be blocks of the total market. There would still be trading. But more likely different entities would trade different versions of the total market. Some would face different expenses than others. Some may be constrained in the mix of securities they can hold. The fund managers could vary in their use of futures and options to remain fully invested while minimizing costs. That would involve different approaches than complete replication at every moment in time.

All of that is before one considers those who emphasize only part of the market. They might say they are passive although I would disagree.

One can have 100% passive and still lots of trading.
We don't know how to beat the market on a risk-adjusted basis, and we don't know anyone that does know either | --Swedroe | We assume that markets are efficient, that prices are right | --Fama

wolf359
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Re: "ETFs Are 'Weapons of Mass Destruction'"

Post by wolf359 » Fri Apr 28, 2017 8:05 pm

JoMoney wrote:
nisiprius wrote:
AlohaJoe wrote:
goingup wrote:Well Jack Bogle did once compare the ETF to the Purdy shotgun--excellent for big-game hunting and terrific for suicide. But that was an entirely different context and an admonition about the ease of trading them.
Recent research has shown that Bogle's theoretical fears were unfounded and people who own ETFs are no more likely to trade them than people who own mutual funds.
Source?
Vanguard has a study, that does show ETFs are more frequently traded, but discounts it as being individuals who want to trade choose ETFs, not that ETFs "tempt" otherwise buy and hold investors into trading
https://personal.vanguard.com/pdf/s318.pdf
... Nonetheless, a substantial difference in trading activity between our mutual fund investments and ETF investments does exist. As Figure 1 showed, although the majority of investments in both share classes exhibit buy-and-hold behavior, a smaller proportion of our ETF investments (relative to mutual funds) lie in the buy-and-hold category and a greater proportion are classified as short-term or hands-on. ...

... We found that, contrary to speculations in the popular media, most investments are held in a prudent, buy-and-hold manner, regardless of share class. Although behavior in ETFs is more active than behavior in traditional mutual funds, some of that difference is simply due to the fact that investors who are inclined to trade choose ETFs, not that investors who choose ETFs are induced to trade...
There's a German study of German investors that showed that ETF owners were more likely to engage in trading behavior, and to underperform the market. Source: https://papers.ssrn.com/sol3/papers.cfm ... id=2022442 They attributed this underperformance to behaviors like short-term market timing and speculative bets on narrowly-defined market sectors.

Vanguard's study involved Vanguard investors, who may not be representative of broad US investors. After all, people seek out Vanguard specifically for low cost and for index trading. Few investors seek out Vanguard to day-trade. Therefore, ETFs probably wouldn't tempt buy-and-hold Vanguard indexers to trade.

However, because the ETF vehicle allows Wall Street to slice and dice the market to target any niche, they probably do convince some people that they could outperform the indices. No studies have been able to prove or disprove this notion, however. They can only show people are either trading or investing, but not why.

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