Bogle: ETF Trading Has No Social Value

September 29, 2011

Heavy ETF trading always was and always will be a fool’s errand, Vanguard founder John Bogle says.

John Bogle is, without question, the conscience of index investing. As the world of ETFs explodes—more than 1,300 funds and counting—Bogle rails with undiminished outrage at the plethora of sector funds, leveraged funds and laser beam-focused exposure schemes. The 82-year-old founder of Vanguard laughs at the idea that the world has passed him by.

Bogle made clear to Managing Editor Olivier Ludwig that owning the whole market through a broad index fund, and holding it for the long term, is what the “simple arithmetic” of indexing has always been about. He hates the excessive trading of ETFs that he says now prevails, because he says it kills investment returns and, moreover, has no social value. Taxing all that trading might make heavy traders think twice, Bogle says.


Ludwig: First of all, I read in Jason Zweig’s recent piece about you in the Wall Street Journal that you fell over the summer and fractured some ribs. How’s your recovery going?

Bogle: I broke four ribs. It wasn’t exactly fun. But like everything else, time heals those wounds.

Ludwig: I’m glad to hear that you’re bouncing back.

So, I’ll jump right into it. I have the privilege of talking to Burton Malkiel from time to time. Professor Malkiel loves ETFs, and the last time we spoke he was saying something to the effect that “Jack has turned the corner on ETFs. He’s less critical than he was in the past.” So, has Professor Malkiel gone off the rails, or do you have something to tell me?

Bogle: No. I’d say I have never changed my opinion. When ETFs first came out, I said, “The ETF is like the famous Purdy shotgun that’s made over in England. It’s great for big game hunting, and it’s great for suicide.”

My problem then and now is that index funds are meant to be used for big game hunting. And if I were trying to capture the market return over a lifetime, I’m going to do fine. But investors that are trading them all day, every day, they are making a terrible mistake. It will be suicidal to their investment capital.

The turnover is unbelievable. SPY, the original, was initially advertised with: “Now you can trade the Standard & Poor’s 500 stock index in real time all day long.” To which I observed, “What kind of a nut would want to do that?”

Ludwig: I would love to witness you and Dr. Malkiel have a conversation about this. He seems to have something of a libertarian sensibility surrounding this issue of heavy trading. He says if people trade ETFs heavily, perhaps foolishly, well then that’s just the nature of the beast. And it’s not our place to legislate or regulate that sort of behavior out of the market.

Bogle: I think investors who are trading in them will eventually lose a great deal of their capital and will learn from their own hard experience. I also think the ETFs have a long way to go in terms of disclosure.

For example, I think it would be useful for ETFs to report not only the returns that they earn over time amongst themselves, but the returns their shareholders earn over time. And you can find enormous gaps between fund returns and ETF returns.

They tend to run about somewhere pretty close to 200 basis points behind the index themselves. That is to say, if the index returns have been, say 5 percent, the shareholder return for the average index that has an ETF is going to be roughly 3 percent.

So, compounded over 10 years, that’s a huge loss of capital.



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