ETF Spotlight

Jack Bogle: ETF market crash talk is bogus, but ETFs do encourage bad behavior

Key Points
  • Vanguard Group founder Jack Bogle said the idea ETFs can cause a market crash is bogus.
  • The latest claims related to Facebook stock exposure in ETFs is no different than all prior questionable claims.
  • Yet Bogle, the passive investing pioneer, does believe traditional index funds are better than ETFs for one reason: they don't encourage bad market-timing behavior.
Bogle: This volatility is of interest to speculators, not long-term investors

Arguments that exchange-traded funds increase market volatility or can even cause a market crash are popular these days, and the Facebook stock tanking provided one more chance for the ETF naysayers to make their case.

It also provided one more opportunity for Vanguard Group founder and index fund pioneer Jack Bogle to say it's most likely a bogus argument.

There are more than 100 ETFs with Facebook among their top holdings. There are more than 230 ETFs with exposure to Facebook.

What does Bogle think of the latest ETF market crash Exhibit A?

"I'm gonna guess we don't know, but I will guess the answer is 'no,'" Bogle told CNBC in an interview Thursday.

The reason is simple, and it's one Bogle has made before: active managers more or less replicate the indexes just like passive funds.

"If you look at the hot stocks, U.S. active managers own almost exactly the same as passive index managers, there's not much difference."

The ETF industry did experience net outflows in February and March, the first time since 2008 there were negative flows in two consecutive months. And Bogle did tell CNBC that in 66 years he has never seen volatility like this.

However, "most ETF investors are buy and hold investors (both advisory and retail accounts)," noted Neena Mishra, head of ETF research at Zacks Investment Research.

Indeed, Bogle told CNBC on Thursday that what we've seen in the market is lots of selling of Facebook shares, not lots of selling by ETFs.

At last year's annual Morningstar investment conference, Bogle answered a question about passive management's rise being a major risk to the market this way:

"If indexing even got up to 50 percent to 60 percent of the market ... still the markets would be efficient and work just fine." He went on: "It's a reasonable question but there's no evidence it happens. All speculative managers hold Apple and Amazon and Alphabet. Active managers own roughly the same percentage of those stocks as the index weight ones. One doesn't want to be too dogmatic, but I don't believe there will be a significant impact."

Bogle does see an ETF volatility link in one big way 

Bogle does have one bone to pick with ETFs. He says they do encourage bad behavior, and that leads investors to lower returns than they can achieve with traditional index funds.

"We have had more and more speculators using ETFs to participate in the market. ... They turn over with fury."

Bogle cited numbers that could not be independently verified to make his case.

"The typical stock on the Big Board or Nasdaq turns over 180 percent to 200 percent a year. We have a trading mentality that should not affect long-term investors, but ETF investors have earned a 5 percent return in the last 12 years and investing in traditional index funds has returned about 8 percent. ... That gap means the traditional index fund investor earned 180 percent on their money and ETF investors about 100 percent. Eighty percentage points in 12 years. ... That's not a good game for anyone but the sellers," Bogle said.

Ben Johnson, director of global ETF research at Morningstar, said he hasn't seen those numbers cited by Bogle, but Bogle is talking about an investing factor that he has studied: the gap between the returns the funds have generated (time-weighted returns) and the returns that investors, on average, have experienced in those same funds once you account for their buying and selling (cash-flow weighted returns).

In plain English, measuring the return of a fund without any trading action over time, versus the return of a fund based on investor flows into and out of a fund over time.

"The gap between the two (which we refer to as the behavior gap) is effectively a self-imposed penalty that investors suffer in their attempts to time the market," Johnson wrote in an email.

Johnson has examined this relationship for index funds versus active funds, but he has not replicated Bogle's numbers using ETFs.

"The gap for ETFs vs. TIFs (as Bogle calls traditional index funds) is no doubt wider, given that the ETF investor base is much different and the use cases for ETFs are far more varied (hedging, shorting, arb trades, etc.) than those for TIFs (buy, hold, rebalance).

"He has always said the worst part of ETFs is that they becomes a trading vehicle that can hurt investors of any size, which contrary to the old index mutual funds, that can only be traded at the end of the day," said Drew Voros, editor-in-chief of But Voros also couldn't verify Bogle's numbers.

Zacks' Mishra pointed pointed out that this is not about an ETF inherently performing worse than a traditional index fund. The SPDR S&P 500 (SPY) had an annualized return of 9.6 percent over the past 10 years.

Vanguard Group was not able to immediately provide a source for the numbers cited by Bogle, but a Vanguard spokesman said it is extremely hard to decipher "speculation" from legitimate, short-term usage of ETFs; for example, for hedging and cash equitization.

The Bogle Center on Financial Markets Research could not be immediately reached.

Bogle has always adhered to the belief that one of the greatest determinants of investing success is keeping it simple — he has even criticized Vanguard Group on select occasions since retiring for launching more funds (both traditional index and ETF) than he thinks are necessary. The many ETFs, which are by nature more tradeable than traditional index funds, can lead investors to unnecessarily deviate from simple buy-and-hold behavior.

There was one comment Bogle made at last year's Morningstar conference that reinforces his belief that while ETFs get more of the attention these days — good and bad — traditional index funds still maintain the upper hand. "The only funds growing faster than ETFs since 2011: traditional index funds," he said.

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