Dangerous Side of ETFs
Investors are no better off because of the last two decades’ explosion of exchange-traded funds.
In fact, according to soon-to-be-published research, investors’ performance probably would have been better had ETFs never existed in the first place.
That’s a remarkable finding, given ETFs’ huge growth, widespread popularity, and undeniable convenience. Since 1993, when the first ETF in the United States was created (the SPDR S&P 500 Trust (SPY), the industry has mushroomed. Globally, there now are more than 6,600 ETFs and other exchange-traded offerings, according to ETFGI, a London-based industry watcher, with total assets greater than $3.5 trillion.
Yet a new study found that investors who own ETFs have performed worse, on average, than those who have avoided them. The study “Abusing ETFs,” has been accepted for publication in the Review of Finance, an academic journal. Its authors are Utpal Bhattacharya, a finance professor at Hong Kong University of Science and Technology, and three professors at German universities: Benjamin Loos, Steffen Meyer, and Andreas Hackenthal.
To be sure, this new research is not the final word on this subject. It’s always possible, for example, that German investors react to ETFs differently than U.S. investors. Professor Bhattacharya said in an interview that he doubts that’s the case, however, since other studies have found the two groups in other contexts to behave similarly. (He added that he would welcome the opportunity to analyze how U.S. investors have reacted to ETFs but that obtaining the necessary data has been difficult.)
One dataset of U.S. ETF-related behavior that does confirm this new study’s conclusion comes from the Hulbert Financial Digest’s tracking of investment advisers’ performances. Over a dozen of them over the last two decades have created separate model portfolios of ETFs, above and beyond those they had previously maintained, making it easy to determine if the introduction of ETFs helped or hurt their performance. Sure enough, their ETF portfolios lagged their non-ETF portfolios by 2.8 annualized percentage points, on average.
But ETFs also make it equally effortless to sell everything and go back to cash, and there’s the rub. You need to be extra vigilant when investing in ETFs in order to avoid doing that just because you can do so easily.
Mark Hulbert, founder of the Hulbert Financial Digest, has been tracking investment advisers’ performances for four decades. For more information, email him email@example.com or go to www.hulbertratings.com.