Exchange traded funds have led to excessive trading and changed the way the stock market works, according to the man widely regarded as the father of passive investing, who is now calling for politicians to re-examine the sector.
Writing in an opinion piece for the Financial Times, Jack Bogle, the founder of the Vanguard Group, the world’s largest passive manager, complains that the annual turnover of shares in the biggest ETF, which tracks the S&P 500, can reach 3,000 per cent of its assets, and that the implications of this “trading — call it speculation — have yet to be fully examined”.
ETFs, introduced 25 years ago, now have more than $3tn in assets. They differ from traditional index mutual funds in that they are traded on stock exchanges, and can be bought and sold several times a day. Turnover at Vanguard’s largest mutual fund, which also tracks the S&P 500, is only 8 per cent each year.
Mr Bogle, who retains a huge influence among investors although he has retired from day to day management at Vanguard, told the Financial Times: “Yes, it is high time both the ETF industry and policymakers re-examine the entire ETF ecosystem. Why? Because of its sheer size and fragility in times of market stress.”
He added that anecdotal evidence appeared to show that this “higher trading activity takes its toll on investor wealth”. Looking at the returns actually paid to investors in Vanguard’s biggest funds — where mutual fund and ETF investors are invested in the same underlying fund — he found that ETF investors’ returns trailed by 1.6 per cent over 12 months.
He also complained that the ETF industry is moving into specific investment strategies, known as strategic beta or smart beta, and concentrated sectors, which charge higher costs. He said the annual expense ratios of strategic beta ETFs (0.24 per cent) and concentrated ETFs (0.33 per cent) were double the charge for broad ETFs (0.15 per cent), and traditional index funds (0.16 per cent).
Vanguard, where Mr Bogle set up the first index mutual fund in 1976, is the leading provider of traditional index funds but is second to BlackRock’s iShares division in ETFs, largely because, as he recounts in the piece, Mr Bogle turned down an offer to launch the first ETF in 1993.