ETFs have added more than $2 trillion in assets globally since 2000.¹ This tremendous growth and adoption have led to a large group of promoters and detractors discussing the ETF structure and its possible implications. What’s the one constant among both groups? Hyperbole. In our discussions with advisors and individual investors about ETF issues, we hear the same general themes emerge. It’s as if these issues were stuck in Bill Murray’s Groundhog Day. Here’s our take:

1. The “F” in ETF stands for “fund.” More than 90% of ETF assets are held in ETFs registered under the Investment Company Act of 1940, the same regulatory framework that oversees mutual funds. Rather than being vastly different from mutual funds, ETFs have far more in common with them.

2. Investors can use ETFs the same way they use mutual funds. Asset allocation … sub-asset allocation … passive exposure to combine with active managers.… Sure, ETFs give you intraday liquidity whereas traditional mutual funds give you end-of-day liquidity, but at the end of the day (or maybe in the middle of the day), the ETF is still simply a vehicle for delivering an investment exposure.

Allocation

3. It’s a case of index fund or nonindex fund, not ETF or mutual fund. Diversification. Low cost. Tax efficiency. These are characteristics associated with indexing. Let’s take a look at two widely known statistics: expense ratio and portfolio turnover rate. As you can see, similarities across the statistics have more to do with whether or not the fund is an index fund rather than whether or not it is an ETF.

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4. Alternatively weighted indexes are just another way to take active risk relative to the broad market. Market-capitalization weighting reflects the consensus valuation estimates of all market participants. Any decision to weight securities differently is an expression of belief that market prices are wrong (i.e., an active view), even if it means simply taking the same exact securities in an index and reweighting them.

5. Premiums and discounts in ETFs are a natural outcome of the relationship between the ETF and its underlying securities. For international stock ETFs, P/Ds happen because underlying markets are closed while ETFs are still trading in the United States. For bond ETFs, P/Ds are a result of higher transactions costs, which are more transparent with ETFs.

6. Tax efficiency is about maximizing after-tax return. Period. The intelligentsia likes to throw out certain statistics as the way to assess ETF tax efficiency. One week, it is capital gains distributions; the next, qualified dividend income percentage; and the next, tax-cost ratio. In the end, just one thing matters: What you keep. That measure is the after-tax total return.

7. ETFs are just another organism in the capital markets ecosystem. Whenever ETFs are portrayed less than favorably in the headlines, we often find ourselves discussing how ETFs aren’t the cause of events. In the past, Vanguard has addressed how ETFs caused neither extraordinary market volatility nor rising correlations. Recently, we saw suggestions that high-yield bond ETFs threatened to “move the market” because of large trading volume in June. We found this odd because (1) not all of an ETF’s trading volume results in flows to the underlying market and (2) the $1.7 billion of outflows from high-yield bond ETFs for that month were substantially less than the $11.7 billion of outflows from high-yield bond mutual funds.²

Maybe to us these issues are repetitious, but we hope that by cutting through the hyperbole, you won’t be stuck in Groundhog Day.

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1 ETFGI LLP as of October 31, 2013.

2 Morningstar, Inc.

Notes:

All investing is subject to risk, including possible loss of principal.

Diversification does not ensure a profit or protect against a loss.