With generally lower expenses, opportunities to hedge, and the potential to be traded throughout the day, exchange-traded funds have enjoyed great popularity recently, but the very elements that make them attractive to investors may also result in lackluster returns, according to The New York Times.
The Hulbert Financial Digest, a service from Marketwatch, monitored 82 newsletters over a 10-year span, each of which tracked the performance of a sample portfolio. In fact, on average, open-ended fund portfolios returned 0.98%, while ETF-only portfolios made 0.76%.
Of nearly 200 newsletters evaluated, only 25 included all-ETF sample portfolios. On average, each of those portfolios lagged behind their open-end mutual fund peers, despite the ability to sell short, expenses as low as 0.09%, and freedom to trade at any time during trading hours, rather than once daily.
For example, Ron Rowland's All Star Fund Trader ranked seventh in overall performance, but his position was compromised by the inclusion of ETFs.
In the Times article, Hulbert columnist Mark Hulbert offered some suggestions as to why ETFs may not capitalize on these apparent advantages.
First, he examined whether the ETFs sought different investment objectives than their traditional counterparts. However, they did not. Rowland, for example, studied 16 sets of ETF and open-ended funds invested in the same asset classes. In all but three cases, the open-ended fund outperformed its ETF counterpart.
Hulbert then examined whether ETFs made smaller gains in the bull market because they took fewer risks. The theory is that because ETFs are not actively managed, they may have been more diverse, thereby missing out on concentrated pockets of opportunity. In fact, he found, ETFs had been slightly riskier, using standard deviation measurements. On a risk-adjusted basis, then, ETFs gained even less than it may at first appear.
So that leaves a third possibility: ETFs are actually riskier than open-ended funds. Their flexibility makes short sales and quick trades attractive options to portfolio managers, but in the end cost more.
"This is just conjecture, of course," Hulbert writes, "but by making it easier to trade often, they may encourage investors to engage in behavior that can endanger the health of their portfolios."