For someone who played such a major role in the introduction and widespread adoption of ETFs, Vanguard Group founder John Bogle has some surprisingly negative perceptions of these products. Bogle’s beef isn’t with the exchange-traded structure (he’s referred to that as a “truly great business model” that helps investors avoid the “tyranny of compounded costs”), but rather the manner in which ETFs are now commonly used by investors.
At first glance, ETFs have obvious appeal to long term buy-and-hold investors. For those who acknowledge what Bogle has called the “relentless rules of humble arithmetic”–the idea that over time active managers won’t consistently beat their benchmark–ETFs offer a cost-efficient alternative. Over an extended period of time, the differences in fees between ETFs and actively-managed mutual funds can translate into huge dollar amounts.
But the big inflows into ETFs in recent years are not attributable to buy-and-holders alone. Some of the other benefits of ETFs have drawn in more active traders who measure their holding periods in days and weeks, not years. The fact that ETFs trade like stocks–throughout the day between market participants–has major appeal to active investors looking to generate alpha by playing macroeconomic trends instead of making company-specific calls.
Much has been made of the threat posed by ETFs to traditional actively-managed mutual funds. While the trend towards ETFs in favor of mutual funds is undeniable, it also seems that ETFs are frequently used as an alternative to individual stocks.
Indeed, a look at some of the trading volumes of popular ETFs sheds some light on just how ETFs are being used–not just as long-term investments by beta grazers but also as preferred vehicles for alpha hunters. Below, we profile five ETFs that may be ideal for buy-and-hold strategies but that are clearly being used by more active traders (shares outstanding from issuer Web sites as of 4/21/2010 and average daily volume from ETFdb.com):
1. S&P 500 SPDR (SPY)
Shares Outstanding: 610.4 million
Average Daily Volume: 185 million
Turnover: 3.3 days
The largest U.S.-listed ETF by assets, SPY is one of the most popular ways to gain exposure to the large cap segment of the U.S. market. While this ETF is a component of countless retirement portfolios, it is also popular as a short-term trade. With daily volume of about 185 million shares, the average holding period in SPY works out to just 3.3 days, a startling figure. By comparison, only about 2% of the outstanding shares of the iShares S&P 500 Index Fund (IVV) trade daily.
2. Financial Select Sector SPDR (XLF)
Shares Outstanding: 417.6 million
Average Daily Volume: 102.1 million
Turnover: 4.1 days
The financial sector has become one of the most volatile corners of the global economy, regularly posting bug one day swings. And nothing draws out the alpha hunters like volatility. Average trading volume of XLF is over 100 million shares, implying an average holding period of four days.
XLF’s turnover is even more remarkable when compared to some of the other sector SPDRs. The Consumer Staples Select Sector SPDR (XLP), for example, trades about 6% of its shares on an average, as does the Utilities SPDR (XLU).
3. SPDR S&P Metals and Mining ETF (XME)
Shares Outstanding: 14.6 million
Average Daily Volume: 5.4 million
Turnover: 2.7 days
Because metals and mining ETFs often trade as a leveraged play on spot prices of the underlying commodities, funds like XME can post big gains or losses over a short period of time. Again, this inherent volatility attracts short-term traders; XME has one of the shortest average holding periods of any non-leveraged ETF at less than 3 days.
Shares Outstanding: 59.5 million
Average Daily Volume: 17.1 million
Turnover: 3.5 days
Following the recent collapse in commercial real estate markets, many investors have begun rethinking the role this asset class should play in a long-term, well-diversified portfolio. The volume figures for IYR suggest that investors are trading real estate rather frequently; the average holding period is about 3.5 days.
5. PowerShares QQQ (QQQQ)
Shares Outstanding: 436.2 million
Average Daily Volume: 89.2 million
Turnover: 4.9 days
QQQQ, which tracks the performance of the tech-heavy NASDAQ-100 Index, is one of the most heavily-traded U.S.-listed ETFs. Since the Nasdaq is one of the three major U.S. stock indexes (along with the S&P 500 and Dow Jones Industrial Average), one might expect investors in QQQQ to be in it for the long haul. But the numbers say otherwise; the average holding period in this ETF is under 5 days.
Disclosure: Long IVV.