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Are ETFs at Odds With Smart Investing?


While the landscape for low-cost fund options for do-it-yourselfers is expanding, John Bogle, founder and retired CEO of the Vanguard Group, believes DIY product offerings are too often inappropriate for long-term investors, who are at risk of being led astray.

Take Motif Investing, which makes it easier than ever for individual investors to create their own ETF-like investment funds around specific themes and social causes, for example. It's not just the everyman investor who's drawn to this idea, though. The company has support from some bold face names as well, with board members including Arthur Levitt, former SEC chairman, and Sallie Krawcheck, former wealth management honcho at Bank of America and Citigroup. While the premise - a do-it-yourself approach to portfolio construction - has struck a chord with many people, it's the ability to personalize one's finances that's the main draw for investors. Bogle, however, is not a champion of this DIY initiative.

Whether you're for or against it, money managers should take heed of the DIY environment. "ETFs took market share away from mutual funds, and Motif could be disruptive to ETFs down the line," notes Robert Goldsborough, an ETF analyst at Morningstar.

In part two of a series, Bogle talks about increased market activity among investors and how DIY competition will impact traditional mutual fund providers, along with his criticisms of socially responsible investment.

Q: The do-it-yourself investment trend is taking off. Is more activity in the market a good thing?

No, no, no. We have data that is overwhelming that shows that the greater the activity, the greater shortfalls of the market. And women get a lot of credit for being smarter investors than men. If you look at the data, you'll see women trade less than men. They're less opportunistic and more content to sit and watch and see what happens. The primary reason women are better investors is that they're in the low turnover group. They're not in that group of investment strategists actively trading their investments. People keep wanting to make an issue of "are men better investors?" and it's a useless argument. We split it every which way. I'm getting tired of that. High turnover is just not a winning strategy. SPDR, the largest ETF, turns over at some 7,000% per year. Actually, 50% to 55% of the largest ETFs are owned by financial institutions, and they turn over on average over 1,000% each year. They're trading. They're taking short positions. They're taking leveraged positions. What we do know is the turnover of ETF shares is colossal: 3,000% to 7000% a year for many large ETFs. And that in turn drives up turnover for individual investors.

Q: So, with Motif Investing, which allows investors to allocate around specific themes and social causes - not the smartest idea from your point of view?

It's a wild card. We look at mutual funds as being for the average investor and ETFs probably are half owned by institutional traders. And the data is all right out there if anybody ever takes the trouble to look at it. That leads to all this trading. So it's a business I think people don't adequately understand. Bottom line: if you want to buy an ETF, fine. It will probably end up costing you a little bit more because you're going to pay those bid-ask spreads where if you buy our traditional index fund your performance is identical except you're going to get 100 cents on the dollar without any spread. If you want to use index funds as Paul Samuelson did to educate his children or use the S&P 500 fund you can conveniently send in $1,000 or $100 or whatever you want to do and it gets invested right away. While you can do that just as easily with an ETF, you must keep in mind the impact of bid-ask spreads.

Q: Speaking of investors taking an active role in their investments, whether or not this is a good idea, does "socially responsible" investment hold a place in a portfolio or does it detract from the sole mission of return?

Social responsibility is available in ETFs and traditional index funds, and the record is very clear that with SRI you lag the market. We started an SRI portfolio after my reign here and that's OK to do after people understood what social responsibility was. A few years ago I got a letter from an investor in one of our index funds and she said she was leaving the fund because of tobacco stocks. She told me what she was going into. So I looked it up: their largest investment was Caesar's World, the casino operator. To each their own on whether Caesar's World is a socially responsible investment. It doesn't make ammunitions; but many might not put it high on their list of socially responsible investments.