Do ETFs turn long-term investors into speculative day traders, as some critics claim?

According to research from Vanguard, ETFs do not turn long-term investors into speculative day traders, as some critics claim.

Not according to a new Vanguard research paper, ETFs: For the better or bettor?, which found that most Vanguard investors exhibit buy-and-hold behaviour whether investing in a traditional index fund or ETF.

According to the new research, critics’ presumptions about ETF trading are typically based on macro-level share turnover data that is dominated by large institutional investors at the fund level – not built on data at the individual investor level.

Using a unique data set of transactions conducted by individual investors, Vanguard researchers analysed more than 3.2 million transactions in more than 500,000 positions held in traditional mutual fund and ETF share classes of four different Vanguard index funds from 2007 through 2011.

“Our individual investor data show that the majority of both traditional mutual fund and ETF investments are held in a prudent, buy-and-hold manner,” said Joel Dickson, one of the study’s authors and a principal in Vanguard’s Investment Strategy Group. “While differences exist between the characteristics of people who buy each investment type, our analysis shows that claims of speculative trading behaviour among ETF investors are greatly exaggerated.”

While Vanguard observed somewhat higher relative trading activity among ETF investments compared with their mutual fund counterparts, some of that difference is simply a reflection of different investors and characteristics associated with the two investments.

For example, the study found that relative to investors in traditional mutual funds, investors who purchase an ETF are more likely to be male, to be over the age of 60, or to check their investment balances at least daily. Analysis of trading behaviour found that people in these three groups tend to trade more often, regardless of which investment vehicle they choose. The authors demonstrated that roughly 40% of the trading activity differences between ETFs and funds are explained by investor and account characteristics.

The study found that contrary to what critics claim, the ETF “temptation effect” – the supposed tendency of investors to trade more after they choose the investment vehicle, because of the availability of intraday trading – is not a likely source of observed high trading volume activity among ETFs.

Vanguard is the third largest US ETF provider by assets under management and leads the industry in year-to-date cash flow of $28.8 billion into US-based ETFs through the first half of the year. The firm manages 64 ETFs with a total of $209 billion in ETF assets. In May this year, Vanguard rolled out an initial suite of ETFs on the London Stock Exchange aimed at UK and European clients.