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Trade-ability is one of the premier features of exchange-traded funds. Yet studies on how investors choose to exercise the right to buy and sell, rather than buy and hold, are only now coming to light.

Yan Zilbering and Donald Bennyhoff of the Vanguard Group recently came up with several intriguing observations on the trading of ETFs. Yet their conclusions focused on some of the more obvious discoveries.

For example, the top 20 most heavily traded ETFs by dollar volume accounted for almost 80% of all ETF trading. This is not particularly surprising. The 80/20 rule works here because the top 20 funds have roughly 80% of all assets under ETF management.

Similarly, the researchers found that the highest turnover rates (i.e., trading activity) could be found with the leveraged and inverse ETFs; inverse ETFs demonstrated higher turnover rates than their leveraged counterparts.

Whereas ETFs may typically trade at a rate of 8% of their monthly assets, Yan Zilbering and Donald Bennyhoff found that Ultra S&P 500 (NYSEARCA:SSO) and Ultra QQQ (NYSEARCA:QLD) had turnover ratios of 61% and 90% respectively. Yet UltraShort S&P 500 (NYSEARCA:SDS) and UltraShort QQQ (NYSEARCA:QID) had turnover rates of 109% and 178% respectively. (Note: Average daily turnover rates can be calculated by dividing the average daily dollar volume by the month-end total net assets for the ETF.)

Still, it should be clear to most folks that daily leveraged and daily inverse ETFs are meant to be traded. In particular, ultra short funds present additional risk by going against the grain, and are sold when short-sellers get “squeezed.”

So am I surprised that the largest fund, the S&P 500 SPDR Trust (NYSEARCA:SPY), represents 1/3 of all trading volume? No… because it contains a similar proportion of dollars under ETF management. Or am I surprised that leveraged funds and inverse funds have unusually high turnover percentages? Hardly… because that’s what investors are supposed to do with them.

On the flip side, here’s what I find exceptionally compelling: In the period studied (1/1/08-7/31/09), investors traded U.S. market ETFs far more often than they traded emerging market ETFs. And that’s not something Yan Zilbering and Donald Bennyhoff discussed.

Turnover Rates For Key ETFs (1/1/08-7/31/09)
Turnover %
S&P 500 SPDR Trust (SPY) 43%
PowerShares QQQ Nasdaq 100 (QQQQ) 43%
iShares China 25 Index (NYSEARCA:FXI) 20%
iShares MSCI Brazil Index (NYSEARCA:EWZ) 18%
iShares MSCI Emerging Markets (NYSEARCA:EEM) 12%

How might one explain the discrepancies? The results may suggest that investors show a greater willingness to stick with emergers like China and Brazil… through thin and thick. Many may be allocating to foreign markets with a greater sense of permanence; in contrast, when it comes to the domestic markets, folks are selling because they feel the need to stand aside.

The implications won’t be known for quite some time. Yet it stands to reason that if investors are more willing to buy-n-hold the emerging growth stories, we know where the next bubble will develop. I’m a big believer in emerging Asia as well as emerging Latin America; that said, you can count me out when frontier investments hit P/Es of 50 like 1999 dot-com stocks.

Full Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. The company may hold positions in the ETFs, mutual funds and/or index funds mentioned above.

Source: ETF Turnover Higher for U.S. Markets