Beware of Easy Trading in ETFs

Keep in mind those who manage the tactical funds are smart, experienced, and credentialed. They also work hard. They have strong economic incentives to succeed. They really are solid investment professionals. Yet, despite their talent and resources, they can’t consistently time the market.

So, ETF investors think they can do better? The record, regretfully, proves the contrary. It appears the ability to trade ETFs intra-day completely destroys their advantages for most investors.

How is this the case? Because investors chase returns and the stories that follow the returns. To examine this, we need to look at a statistic called investor return. This is the return investors actually get from an investment taking into account when and how much they buy and sell. This is the bottom line number.

The investor returns for ETFs are not good. Just look at the behavior gap for ETFs in the table below. The behavior gap is the difference between a fund’s investor return and the fund’s stated total return in that same fund. Since investors typically buy after prices have gone up and sell after prices have gone down, investor returns are lower than fund returns. This has been well-studied among mutual funds. Yet, for ETFs, the record is currently worse. Much, much worse.

Using data through 8/31, we looked at 3-year total returns and 3-year investor returns. The behavior gap is investor return minus fund return. In the table below, looking at all equity peer groups in Morningstar that had data, only 16% of the peer groups had positive behavior gaps. The average behavior gap (equal-weighted) was -13%; the median behavior gap was -17%.

So while ETFs are indeed the better investment vehicle (in most cases) than mutual funds, it appears easy trading makes them worse for most investors.

What does this all mean for investors?

  1. All else being equal, lower costs are good for investors. ETFs help lower costs and put money back into investors’ wallets. This is why ETFs are so popular and why they will become even more popular.
  2. Controlling emotional trading/investing, however, is even more important than controlling costs. Regretfully, since ETFs are so easy to trade, it appears that many investors tend to react too quickly to market noise and, in turn, hurt their investment performance.
  3. To help counter the problem of chasing performance, the importance of quality investment counseling and active portfolio management must be stressed.

Rusty Vanneman is the Chief Investment Officer at CLS Investments, a participant in the ETF Strategist Channel.

Disclosure Information

This information is prepared for general information only.  Information contained herein is derived from sources we believe to be reliable, however, we do not represent that this information is complete or accurate and it should not be relied upon as such.  All opinions expressed herein are subject to change without notice. The graphs and charts contained in this work are for informational purposes only.  No graph or chart should be regarded as a guide to investing.