Although ETFs have, for the most part, been widely embraced by the investing public, they are not universally loved. Vanguard Group founder and legendary investor Jack Bogle, whose efforts are responsible in no small part for the tremendous popularity of exchange-traded products, has lamented that an investment model best equipped for buy-and-hold has become a favorite tool of short-term speculators. The list of analysts and investors who believe (incorrectly) that leveraged ETFs are fundamentally dishonest products is a mile long.
And now, in his latest online rant, billionaire tech entrepreneur and Dallas Mavericks owner Mark Cuban even takes a shot at the role ETFs play in today’s financial markets.
The investor allows entrepreneurs access to capital and allows them to work with it and build businesses, which in turn build employment and do great things for the economy. The trader/speculator pushes companies to make more money now rather than invest in doing the right thing for the company. The trader/speculator dominates the stock market today, which in turn puts pressure on public company CEOs to cut jobs and play games with their financials in order to give the appearance of stability in a far from stable market. The investor understands the bigger picture and is ok if profits fall for several quarters or even several years as long as the company will maximize its return over the long run.
The government should raises taxes significantly on profits from short term capital gains on the sale of public stocks, indexes, commodities, futures held for 24 hours or less and extend the length of time required to qualify for Long Term capital gains and reduce the tax rate on Long Term gains. This will discourage flash trading, ETFs that move markets purely on cash inflows rather than fundamentals and also reduce the amount of speculation on commodities. It will also reward companies that act in the financial interests of long term holders and their employers. I think the impact on the economy would be far fewer layoffs as CEOs find themselves with more shareholders who think long term rather than short term.
Cuban seems to believe (not unreasonably) that the widespread use of ETFs by short-term investors makes markets less attractive, less profitable, and less efficient for long-term investors. He’s certainly not alone. The role of leveraged ETFs in exacerbating market volatility, particularly in the final hour of trading, has been a hot topic for some time. And earlier this month, the Commodity Futures Trading Commissions held public hearings to determine whether position limits should be put in place on commodity investments (the impact of this issue has been felt by investors in UNG, which is currently trading at a huge premium to its NAV). Finally, former IBM CEO Louis Gerstner, Jr. recently proposed in an interview with Bloomberg taxing day-trader profits at 80%,
Cuban makes a few good points. But he also misses the boat on a few of his ideas:
- I’m skeptical that there are many CEOs out there willing to lay off fewer workers if they had a few more long-term investors in their stock
- Cuban implies that because of speculators, CEOs focus on maximizing current quarter EPS. This is certainly an issue, but speculators are also active on days when earnings reports aren’t being released, so Cuban appears to be confusing a few different concepts here. Speculators are traditionally despised for driving prices up and down for irrational reasons, and I don’t think that any CEO is foolish enough to attempt to devise a solution for unknown irrational behavior. Cuban’s frustration may be more appropriately directed at the Wall Street analysts that place a great deal of weight on current EPS (and those who make investment decisions based primarily on EPS).
- Speculators and day traders may distort market prices for reasons unrelated to company fundamentals, but they also provide value in the form of liquidity. Be careful what you wish for, Mark.