Schaeffer's Trading Floor Blog

Why Timing is Critical with ETFs

Are ETF players more trigger-happy?

by 8/12/2014 8:23 AM
Stocks quoted in this article:

The only thing we have to fear in the exchange-traded fund (ETF) market is fear of missing a move or something like that.

Brendan Conway makes an interesting point in his Barron's column. ETFs are designed for more active investors than standard mutual funds. But that's often a quite unhelpful feature:

Let's start with the most obvious error: Chasing rallies in niche ETFs. The appeal of many specialized ETFs is their ability to give instant exposure to a market sector. The hard part is benefiting from that exposure. Take the Global X Social Media Index ETF (ticker: SOCL). This basket of social-media stocks soared 64% last year. Waves of investor cash chased the strong performance, but much of the money was for naught, as the sector's March selloff coincided with the ETF's peak inflows. Poor market timing isn't limited to niche areas, though: Investors poured money into short-term bond ETFs amid 2013's rising interest-rate fears, only for investors to see the long end of the curve prosper in 2014.

Vanguard Group founder John Bogle famously distrusts ETFs, arguing that the ease of trading encourages investors to sabotage their own best interests. The thing is, investors do a fine job of self-sabotage on their own, and trigger-happy investors surely self-select their way into ETFs. Consider, for instance, Morningstar's "investor return" statistic, which shows the average mutual-fund investor trails the fund's return by 2.5 percentage points a year, due to buying and selling at the wrong times. That's a bigger hit than high expense ratios. Morningstar doesn't publish an "ETF investor return" statistic, citing the presence of arbitrageurs and other factors that muddy ETF money-flow data. But Ben Johnson, head of Morningstar's passive fund research, offers this: "Oftentimes, the most sound course of action is just to do nothing."

My first thought was that this is probably true in every sort of asset and method of investing in that asset. In other words, I'd guess that investors pile into regular mutual funds and hot individual stocks at precisely the wrong times. So, do ETF players really stand out?

Well, looks like they do.

HERE'S A TELLING STATISTIC in self-defeating ETF behavior: Researchers at Vanguard found that ETF owners were more than twice as likely as mutual-fund investors to log onto their accounts every single day -- something you wouldn't do without a finger on the button. "Those that go in and look at their account want to fiddle," says Vanguard strategist Joel Dickson. "Investors really should get out of this habit of having to look."

I'm guessing that's not a habit anyone's breaking soon.

Here's a bit of irony, though: Our favorite ETF here is the iPath S&P 500 VIX Short-Term Futures ETN (VXX). And by "favorite" I don't mean as an investment vehicle, but rather as a product to discuss, as it's the most popular of the growing family of tradable volatility.

But as I hope you know, it's best used ONLY as a trading vehicle. The last thing in the world you should do is hold it for any appreciable length of time. And I mean any length.

As per the data we ran last week, buying and holding VXX for a random five-day trading period has produced a median return of negative 2.3%. Hold for 15 days and your median return is negative 7.3%, and hold for 25 days and it's negative 11.5%.

Now granted, VXX opened up shop in early 2009, so it has only existed during a generally rising VIX backdrop. So perhaps five to 10 years from now, those numbers won't look quite so hideous. But they'll still all be negative, thanks to the perpetual contango in VIX futures.

But regardless, if you feel the need to play VXX, you absolutely should actively check and trade it. Whether you should feel the need to play it to begin with is the better question.

For most of the rest of the ETF universe, the point in the article does make sense. Just because it's easier to buy and sell ETFs than regular mutual funds doesn't mean it's something you should do more often. Timing investments well is incredibly tricky. We all feel the need to do something when it gets more volatile, but often patience is the best course.

Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.

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