Are ETFs a better investment over the shorter or longer term?

Jun 27th, 2016 | By | Category: ETF and Index News

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Exchange traded funds are often touted by providers as being an ideal vehicle for short-term decisions and tactical investors due to their intraday liquidity, but a new study argues that ETFs are best held over the longer term.

Are ETFs better for long term or short term investment?

Are ETFs better for long term or short term investment?

The June 2016 study from Vanguard, called “The Case for Low-Cost Index-Fund Investing”, said that time horizon is an especially important factor for investors who want to pay less in fees, see higher returns and favourably compare performance of passive versus active funds.

With active funds, market cycles and “simple luck” can impact returns over shorter time horizons, it argued.

“These short-term effects can mask the relative benefits of low-cost index funds versus active funds in two main respects: the performance advantage conferred on index funds over the longer term by their generally lower costs; and the lack of persistent outperformance among actively managed funds,” the study read.

It is not hard to spot a glut of active funds that have performed well over a few years. In the emerging markets category Citywire data shows that David Gait and Jack Nelson’s £291 million Stewart Investors Global Emerging Markets Sustainable Fund has delivered over 28% in the last five years, compared to the iShares MSCI EM UCITS ETF (IEEM) which has fallen over 2% in the same timeframe.

But the Stewart Investors fund is the exception, and there is no guarantee how long that outperformance will continue. Out of 116 funds in the Citywire emerging markets category, 89 of them underperformed the market – in other words, fell short of the iShares ETF – over five years.

“As the time period examined becomes longer, however, the effects of luck and market cyclicality tend to cancel out, reducing the number of funds that outperform,” according to the Vanguard research.

When looking at actively-managed US equity funds, the study found that around 50% of them underperformed the benchmark over a rolling one year period from 2014, yet closer to 70% underperformed over a rolling 10-year period from 2006.

In Europe, the majority of ETFs are used by institutional investors, while in the US it is the retail market that makes up nearly half of ETF investors. It means that in Europe, ETF inflows and outflows continue to be one of the best barometers of investor sentiment.

Another point Vanguard mentions is that the benefit of the low-cost nature of passive funds is only truly advantageous over the longer term.

“For example, a 50-basis-point difference in fees between a low-cost and a higher-cost fund may not greatly affect the funds’ performance over the course of a single year; however, that same fee differential compounded over longer time periods can make a significant difference in the two funds’ overall performance,” it read.

The aforementioned iShares ETF costs 0.75% – significantly above the average ETF cost – but the Stewart Investors fund has a higher annual price tag of 0.90%. iShares also offers ETFs that track the MSCI Emerging Markets Index for fees as low as 0.25%.

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