John Bogle: High Court Fell Short With Fees Ruling

April 08, 2010

Cachet is something we should be very careful of when we get into investing for a lifetime. The investors in those leveraged ETFs, as a group, are almost bound to lose. You’ve been negative on ETFs in the past, saying they can hurt investors, and I’m wondering if you still feel that way now?

Bogle: The ETF is fundamentally not a problematic investment. If you buy a Vanguard Total Stock Market ETF on the one hand, or the Vanguard Total Stock Market regular fund, how can I say the ETF is a bad thing? They’re the same thing. The ETF might be a little cheaper from Vanguard’s standpoint in terms of annual expense ratio, but you have to pay a commission more often than not and a spread to obtain it. If you’re going to put $1 million in it once and hold it forever, you’re probably better off going the ETF route, but if you’re putting in $100 a month, you’re much better going the regular route.

When you look at ETFs, there are two problems. There are around 800 of them. About 15 of them are all that I would call classic index funds: total U.S. stock market, S&P 500, total
bond market, developed international markets and perhaps emerging markets. The rest are narrower segments—it might be various industry sorts, it might be individual countries, it might be subindustry groups.

So one problem is that ETFs have departed so much from the sweeping broad nature of what classic indexing is about, which is owning markets and capturing market return. Then you’ve got people that enter the business like [Rob] Arnott [of Research Affiliates] and Jeremy Siegel [of WisdomTree] who are providing indexes that will “beat the market.”

The second problem is trading. We have some funds that will give you double or triple leverage on the upside, and if the market’s going down, you can bet on that and make a lot of money—double or triple. So there’s a lot of stuff being thrown around in ETF-land because ETFs are hot. If you want to start a line of funds, you start them in ETFs. And you capture the cachet of having a fund you can trade all day long.

Cachet is something we should be very careful of when we get into investing for a lifetime. The investors in those funds, as a group, are almost bound to lose. What about the tax efficiency of the ETF relative to the traditional mutual fund?

Bogle: ETFs have a theoretical advantage of tax efficiencies, but it’s never been proved out in terms of reality. First, there’s a lot of tax inefficiency when changes are made in the index, and there’s a lot of fooling around in these subsectors, and then changes made in the fund itself. It’s the trading in fund shares that doesn’t require you to realize capital gains. So there’s no evidence that the tax efficiency is very much different. I would also add that half the mutual fund equities are held in pension plans and 401(k)s, so it’s not a tax problem in the first place. I regard that as a claim that is technically good but doesn’t really exist. What do you think of the SEC’s decision to put a stop, for now, to actively managed or leveraged funds that use derivatives? Do you think the SEC is providing adequate oversight?

Bogle: I have an embedded dubiousness about the SEC being able to regulate in an intelligent way the kind of products that are being offered. But I agree with the decision. Not everybody knows that they promise returns for a day. If you hold them for a month, and the market goes up 20 percent, you might think it should go up 40, but it doesn’t happen. So they’re very subject to misunderstanding, and if they can’t be explained with examples, then they should not be able to be offered.


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