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Jack Bogle: “our ETF investors trail our index fund investors by 1.6%”

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The Financial Times have been running a series called “Age of the ETF”. In today’s installment Jack Bogle makes an interesting claim:

“Vanguard’s patented structure for ETFs — in which both its Tifs and ETFs are shares of the same underlying portfolio — presents a unique test case for evaluating investor outcomes in the two types of index funds. Over the past months, Tif investor returns were a few basis points higher than fund returns in each of the five largest Vanguard broad-market index funds. In contrast, returns earned by the firm’s ETF investors — owning the identical underlying portfolios — trailed the returns of the funds by an average of 1.6 per cent during the same period. This anecdotal evidence seems to confirm the consensus that higher trading activity takes its toll on investor wealth.”

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Posted by vlad
Posted on 12/12/2016 1:10 PM
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Yeah, the most actively traded positions at the NYSE every day are ETFs. People have started trading these things just because you can. It’s become so low cost and easy that people can’t seem to control themselves. Mutual funds are nice because they don’t trade. But the mutual funds are also less tax/fee efficient. For instance, with Vanguard’s Total Bond MF and ETF you have the exact same fund, but the MF is 10 bps more expensive AND results in 10 bps of tax cost. The ETF earns a 20 bps premium after taxes and fees. But you only earn this premium if you can resist the urge to trade the ETF in the short-term.

So it’s all behavioral. Bogle likes MF’s because they better control someone’s behavior. He’s right. But only for the right person. Otherwise you should definitely own the ETFs.

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Cullen Roche Posted by Cullen Roche
Answered on 12/12/2016 1:27 PM
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    A large part of my portfolio is with Vanguard and I have a couple of counter-points (ok, perhaps 1 and 1/2 points):

    1. if you constrain your Vanguard allocations to satisfy their “Admiral Shares” requirements, the fees drop. Taking your Total Bond example, VBMFX expense ratio is 16 bps, but VBTLX is 6 bps, the *same* as the BND ETF. The minimum investment for Admiral class is only $10k, so I think it is more accurate to compare BND with VBTLX.

    2. regarding tax costs, your point is valid and I can only apply the known solution: all my bond funds are in the tax-deferred subaccounts. I am lucky to have enough room (for now).

    I know myself well enough to say that *I* can resist the urge to trade ETFs, but the issue is that not all of this is guaranteed to be up to me: I am talking about the infamous “liquidity mismatch” issue. If an ETF sells off in a stampede and the resulting volume of redemptions is larger than the underlying capitalization, what is going to happen?

    There have been some impressive stress-tests by the market (https://www.bloomberg.com/news/articles/2015-12-14/five-mind-blowing-stats-from-the-selloff-in-the-biggest-junk-bond-etf), but the tail risk remains and it’s unclear how to price it in bps. For that reason, I like the extra redemption “gates” imposed by mutual funds.

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    Posted by vlad
    Answered on 12/12/2016 2:03 PM
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      Hi Vlad,

      Sounds like you’re in a great spot and well informed. You’re 100% right on the Vanguard fund info.

      The liquidity mismatch issue is, IMO, only relevant for certain funds. For instance, if you own a highly illiquid junk bond ETF then you could see some pretty unnerving bond price swings in a nasty bond bear market. BUT the kicker is knowing that the illiquidity is irrelevant to the person who doesn’t have to sell the fund. So it’s a behavioral issue again. And the odds are, if bonds are having a liquidity dislocation then that’s the time to be BUYING and not to be selling. So, if you ask me, I’d say that’s an overstated concern for most people who are using these products the right way and within the proper time horizons.

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      Cullen Roche Posted by Cullen Roche
      Answered on 12/12/2016 3:06 PM
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        Well if no one traded their ETF, then there would be no price discovery !!!

        And most ETF trading is done by algos such as Jim Simons, so measuring the “return of ETF holders” has no relevance to mom and pop whatsoever.

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        Posted by FUЯ ION
        Answered on 12/13/2016 11:35 AM
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          Nobody said ETFs are in danger of “no one trading them” — very far from it.

          If you read what Bogle actually said, the conclusion is fairly simple: Vanguard Admiral Shares and ETFs are different share classes of the *same* underlying fund. Hence, the portfolio underperformance of those who choose the ETF version can only be due to their own “trading”, i.e. altering the portfolio allocations (i.e. entering/existing their ETF position mix) at suboptimal times — suboptimal relative to simply buying and holding over a ~12 month period. Since ETFs are, well, “exchange traded” the temptation to trade is too great for too many.

          This has nothing to do with who else is trading ETFs to drive the price discovery. Even if 99% of the trading volume is due to “Jim Simons”, the remaining 1% of participants can still enter and exit the ETF price trajectory so as to have a sub-par P/L. Retail traders are known to be P/L losers on average.

          https://www.ft.com/content/f406d50c-bbcf-11e6-8b45-b8b81dd5d080
          https://www.ft.com/content/855c1152-be37-11e6-8b45-b8b81dd5d080

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          Posted by vlad
          Answered on 12/13/2016 1:36 PM
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            As you likely know, I promote a fairly long-term strategy. It’s cyclical so I always tell clients that if you view my strategy on anything less than about a 5 year time horizon then you’re doing it (and yourself) a disservice. After all, you are literally misunderstanding the product if you own something like a 5 year bond aggregate and you judge it on a 1 year basis….But the funny thing is that 100% of the people who come to work with me tell me they understand this upfront. And I still probably have about a 10% client turnover rate.

            So, how crazy is this – I am professing a very simple low cost strategy. And I explicitly explain why, OPERATIONALLY, you can’t view that strategy in short time horizons. And 10% of those people who have good behavior being coached by a very competent manager, will still abandon ship….

            So, it’s not at all shocking that people who are tempted to trade ETFs end up trading them thinking that they can generate better short-term results in doing so….It’s the illusion of control by action.

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            Cullen Roche Posted by Cullen Roche
            Answered on 12/13/2016 1:43 PM
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              “And I explicitly explain why, OPERATIONALLY, you can’t view that strategy in short time horizons.”
              But you haven’t explained why emotionally people can’t do that.

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              Posted by FUЯ ION
              Answered on 12/13/2016 7:47 PM
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                I don’t envy Bogle’s job. He has his hands and mind completely full just in getting below average investors who don’t want to learn to rise up to being average. Hopeless.

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                Posted by MachineGhost
                Answered on 12/27/2016 2:56 AM
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