Have ETFs Enabled Day Trader Nation?

Detractors of exchange-traded fund investing have long argued these products are one-dimensional trading tools that seduce people into hyperactive trading. Have ETFs turned people into day traders?

The 1990s were a major turning point in the public’s attitude and behavior toward investing. Back then, the day-trading culture took off as online trading gained in popularity. Hyperactive trading was fueled by hot initial public offerings in the internet and technology sectors.

Today, some people suggest that ETFs are being used as stand-alone trading vehicles with no other purpose but to encourage hyperactive trading. But it simply isn’t true. In truth, ETFs have become an important tool in both portfolio construction and management.

Morningstar’s latest “ETF Managed Portfolios Landscape Report” shows that total assets in professionally managed ETF portfolios held steady during this year’s first quarter, near $121.9 billion. Twelve of the 20 strategies with the largest quarter-over-quarter percentage increases in assets were plain vanilla stock/bond strategic asset allocation portfolios.

What does this all mean? Asset flow trends are signaling an increasing preference by investors for managed solutions, with ETFs being used as the primary building blocks. And rather than converting the investing public into day traders, ETFs have helped them—along with financial advisors—to build portfolios that are more diversified, tax friendly and cost efficient.

What about the common assertion that massive daily ETF volume proves that ETFs are being used to speculate? This claim was made by Vanguard Group founder John Bogle in a Barron’s interview in May. According to Bogle, the 100 largest ETFs have turnover of 785% compared to just 144% for the largest 100 stocks. In reality, Bogle’s statistics provide little evidence that mom-and-pop retail investors have turned into ETF day traders.

The fact is the bulk of ETF trading is done by large institutions, not retail investors. This has always been the case since the first U.S.-listed ETF launched in 1993. If Bogle has a bone to pick about hyperactive trading, it should be with institutional investors, not with the retail crowd.

Vanguard conducted its own examination of ETF trading activity in 2012, and the findings contradict Bogle’s entrenched arguments that ETF shareholders are short-term speculators. The study, titled “ETFs: For the Better or Bettor?” scrutinized more than 3.2 million transactions in more than 500,000 positions held in the mutual fund and ETF share classes of four different Vanguard funds from 2007 through 2011. By obtaining information from the transaction and account records of actual Vanguard clients, the company was able to get to the bottom-line truth of how investors are really using ETFs.

The study’s results showed that 99% of traditional mutual fund investments and 95% of ETF investments did not exceed a rate of four reversals or changes in investment direction per year. Furthermore, less than 1% of ETF positions averaged more than one investment reversal per month. That’s hardly a sign of ETF day trading.