Let’s face it: Without John Bogle, there would have been no Journal of Indexes. The launch of the Vanguard 500 Index Fund nearly 40 years ago spawned a revolution in the investing world. Today indexed assets continue to grow, steadily eroding the active management stronghold, and Bogle has been beatified by his most devoted followers as “Saint Jack.” But “complacent” was never a word used to describe him—he still thinks there’s a lot that investors need to watch out for.
You have been very clear that you think the ease of trading is one of the pitfalls of ETFs. Do you think if an investor uses ETFs within a disciplined or systematic rebalancing scheme, ETFs can work well in a portfolio?
Well, if you do buy and hold ETFs rather than trade them, it depends on how often you rebalance. I don’t know how many investors actually do that, but in that case, ETFs will probably not do any irreparable harm. I would give ETFs that. That might not be the greatest marketing tagline you’ve ever heard though: “It will not do you irreparable harm if you buy, hold and rebalance systematically, as long as you do not do so too often.”
One other thing that everybody should know is if you’re moving out of technology and into health care, to give you one example, somebody else is moving out of health care and into technology. It’s a zero-sum game—for every buyer, there must be a seller. You may be on the winning side or may be on the losing side, but for investors as a group, it’s zero sum, less the cost of investing, less the trading costs, management fees and those other things—expense ratios, taxes. You’d better be sure you’re right, but if you’re sure you’re right, you’re a damn fool. You may like to be right, you may hope to be right, but to be sure you’re right is the formula for investment failure.
I also worry about speculation in the SPDR S&P 500 ETF (SPY | A-98). That’s what ETFs seem to be all about—trading. Each day, The Wall Street Journal lists the 12 most widely traded stocks by number of shares. In dollar volume, every day, the SPDR is the most widely traded stock in the world. On a typical day, half or more of the 12 most active stocks are ETFs.
It is a whole new dimension of activity for the brokerage community, which thrives on trading by investors. And in fairness, a lot of what is happening in SPY and in all ETFs is a very heavy institutional participation. Something like 75 percent of the shares of SPY are held by institutional investors. Investors are making big bets on the market to go up or, if they’re short, on the market to go down. The shares may also be owned by an institution that fired a manager and wants some market exposure before hiring another manager. Why they would leave the index fund is not quite clear to me. The index fund would be the best place to stay, but they’re always looking for active managers with strong past performance, which simply doesn’t work.
But even individual investors are trading heavily. We don’t know exactly how heavily. SPY turns over at something like 5,500 percent a year, and that is just taking that annualized trading volume as a percentage of the fund’s assets. It did $28 billion in volume the other day, and the SPDR itself is around $195 billion. I should say in full disclosure, I think 3 or 4 percent turnover is pushing your luck, and 5,500 percent is simply not on my chart.
Now we have this great marketing device, the ETF. It’s in the news. It’s hot. It’s a way to bring people aboard the mutual fund train after it has left the station. As an industry, we have to know that all this trading does not help investors as a group, and yet we leap into this new business, because we have become a marketing business. I yearn for the day we get back to our roots—the asset management profession—and get out of the marketing business.