With so many investors flocking to exchange traded funds, Vanguard has asked its researchers to find out what’s driving that behavior. The answer, in a nutshell, is that for ETF investors, familiarity breeds contentment.
“Our analysis finds that the decision to buy the ETF share class is largely driven by a set of factors we have dubbed the ‘FACTS’: familiarity, access, costs, trading flexibility and stocks. Foremost among them is familiarity,” wrote Vanguard authors Joel Dickson, Stephen Weber, David Kwon and John Ameriks in a white paper released on Wednesday.
Released on Wednesday, the paper, “Buying on the FACTS: Investors’ choices between ETFs and mutual funds,” notes that investors who have purchased ETFs before are much more likely to do so again the next time they face a decision between a mutual fund and an ETF. (On the same day, Vanguard published a second ETF research paper, “Understanding Synthetic ETFs,” which explains their potential benefits and risks and discusses best practices for synthetic ETF collateral management and disclosures.)
For ETF investors, access is also a key determinant, “as investors must have a brokerage account to buy an ETF, and the lack of one appears to be a significant barrier to entry,” according to the authors, who used client transaction data gathered by Vanguard’s Client Insight team.
Analyzing purchase decisions made by self-directed investors when buying a new investment, Vanguard’s researchers looked at investors who could have chosen either an ETF or a mutual fund to achieve the same exposure, and then examined why a particular choice was made.
Along with familiarity and access, costs play an important role because investors are more likely to choose an ETF over a mutual fund if no commission is charged, if the mutual fund has a purchase fee, or if the ETF offers a lower expense ratio. Trading flexibility in ETFs appeals to investors who prefer a more hands-on approach, says the white paper, and investors are more likely to buy ETFs in a stock fund than in a fixed-income fund.
“Furthermore, active traders as well as equity investors are more inclined to choose ETFs,” the authors write. “Taken as a whole, this framework can be useful for understanding the growth of ETFs among retail investors and suggests that such growth may continue as ETF adoption begets ETF adoption.”
ETFs’ rapid growth relative to traditional funds is “somewhat surprising considering the similarities between the two products,” the Vanguard authors add. “Although traditional mutual funds remain the dominant form of pooled investing in the United States, ETFs have grown rapidly and become the investment of choice for many investors.”
They point to data showing that assets in U.S.-listed ETFs grew to $1.3 trillion in 2012 from $102 billion in 2002, for a compound annual growth rate of roughly 30%. This compares with roughly 12% annual growth for traditional mutual funds. U.S. mutual funds excluding money-market funds held $9.3 trillion in assets as of Dec. 31, 2012, according to Morningstar.
Read a debate on ETFs between Vanguard founder John Bogle and ETFGuide.com’s RonDeLegge with DeLegge’s Why Bogle Is Dead Wrong on ETFs and Bogle to DeLegge on ETFs: ‘It Is You Who Are Dead Wrong’ at AdvisorOne.
For direct insights on the role of ETFs in client portfolios from multiple experts—including Rick Ferri, Ron DeLegge, Skip Schweiss and more—we invite you to register for AdvisorOne’s premiere advisorcentric Virtual ETF Summit, which starts July 23 (and get multiple hours of CFP Board CE).