Retail ETF investing

• Published date: 01 September 2024
• Author: David Gempesaw,Joseph J. Henry,Han Xiao
• Date: 01 September 2024
• DOI: http://doi.org/10.1111/eufm.12471

DOI: 10.1111/eufm.12471

ORIGINAL ARTICLE

Retail ETF investing

David Gempesaw

1

|Joseph J. Henry

2

|Han Xiao

3

1

Farmer School of Business, Miami University, Oxford, Ohio, USA

2

D'Amore‐McKim School of Business, Northeastern University, Boston, Massachusetts, USA

3

School of Management and Economics, Chinese University of Hong Kong, Shenzhen, Guangdong, China

Correspondence

David Gempesaw, Farmer School of

Business, Miami University, 800 East High

St, Suite 2053, Oxford, OH 45056, USA.

Email: dgempesaw@miamioh.edu

Abstract

Using marketable order flow data, we analyze key

characteristics of aggregate retail exchange‐traded

fund (ETF) investing from 2010 to 2021, including

allocations, holding period and investment perform-

ance. Retail traders allocate 12% more dollar volume

to leveraged and inverse ETFs versus nonretail

traders. Retail ETF trades distinctly increase with

prior ETF returns, in contrast to contrarian stock

trading. Estimated ETF holding periods are longer

for retail investors versus nonretail. Finally, retail

and nonretail ETF trades perform similarly over

hypothetical holding periods up to one quarter.

Overall, we provide policy‐relevant insights into

retail investing behaviours, which have been the

subject of recent concern.

KEYWORDS

ETF, exchange‐traded fund, net dollar volume, proportional

trading model, retail investors

JEL CLASSIFICATION

G11, G12, G23

Eur Financ Manag. 2024;30:2305–2342. wileyonlinelibrary.com/journal/eufm

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This is an open access article under the terms of the Creative Commons Attribution‐NonCommercial License, which permits use,

distribution and reproduction in any medium, provided the original work is properly cited and is not used for commercial purposes.

© 2023 The Authors. European Financial Management published by John Wiley & Sons Ltd.

We thank the editor, Dr. John A. Doukas, and two anonymous referees for their valuable comments and suggestions

which have substantially improved the quality of the paper. We thank Raisa Velthuis for helpful comments and for

lending her expertise with the TAQ data, as well as Larah‐Ann Petersen for excellent research assistance.

1|INTRODUCTION

Investors have enthusiastically embraced U.S.‐listed exchange‐traded funds (ETFs) since their

introduction in 1993. Named ‘one of the most successful financial innovations of the past few

decades’by the Financial Times,

1

ETF total net assets grew to $1.3 trillion by 2013 and $7.2

trillion by 2021.

2

In addition, ETFs now account for roughly 37% of all U.S. equity trading.

3

Fuelling this growing popularity, the ETF asset class caters to a wide variety of overlapping

investing motives. Like many mutual funds, ETFs provide exposure to the performance of large

baskets of equities or bonds that might be desired by an uninformed, long‐term investor. Unlike

mutual funds, the intraday liquidity of ETFs facilitates short‐term speculative trading. ETFs

also provide access to complex trading strategies involving leveraged, inverse (i.e., short), and

futures contract‐based positions.

Retail investors represent an important group of participants in the growing ETF

market. For example, 82% of institutional respondents in a 2022 PwC survey expect retail

investors to be a source of significant demand in the U.S. ETF market over the next several

years.

4

More broadly, retail investors have developed a reputation as a ‘crazy mob’for

their correlated and ill‐advised trading preferences (Welch, 2022), while emerging

research by Tamoni et al. (2023) identifies small investors as a primary driver of variation

in anomalous equity returns. Concerns about retail ETF trading include overtrading and

easy access to complex trading strategies with high risk (see Supporting Information

S1: Table IA3). Furthermore, the U.S. Securities and Exchange Commission (SEC) has

scrutinised and issued warnings about complex ETF strategies as part of its mission to

protect Main Street investors,

5

and its leadership has challenged researchers to examine

where retail investors put their capital.

6

Despite the widespread popularity of these funds,

an extensive academic literature examining retail investor behaviour and performance in

other asset classes (e.g., Barber & Odean, 2013), and growing attention from stakeholders,

market observers, and policymakers, our understanding of retail investors' use of ETFs

remains limited.

In this paper, we examine key characteristics of retail ETF investing using data on filled

marketable ETF orders from 2010 through 2021. As Welch (2022) does for retail ownership of

individual equities, we address fundamental, unanswered questions about retail investing

1

Editorial Board (2021, Jul 21). The inexorable rise of exchange‐traded funds. https://www.ft.com/content/2cdfce0e-

d0d1-4076-8026-4115d2b8b1ee.

2

According to the 2022 Investment Company Fact Book.

3

Mackintosh, J. (2019, Aug 30). How ETFs Swallowed the Stock Market. https://www.wsj.com/articles/how-etfs-

swallowed-the-stock-market-11567162801.

4

PwC (2023, Mar 29). ETFs 2027: A world of new possibilities. https://www.pwc.com/gx/en/financial-services/

publications/assets/etf-2027-report.pdf.

5

For example, SEC staff were directed in late 2021 to study the potential risks of products like leveraged and

inverse ETFs.

See Gensler, G. (2021, Oct 4). Statement on Complex Exchange‐Traded Products. https://www.sec.gov/news/

public-statement/gensler-statement-complex-exchange-traded-products-100421.

See also SEC Office of Investor Education and Advocacy (2023, Aug 29). Updated Investor Bulletin: Leveraged and

Inverse ETFs. https://www.sec.gov/investor/pubs/leveragedetfs-alert.

6

Crenshaw, C. (2022, Apr 14). Grading the Regulators and Homework for the Teachers: Remarks at Symposium on

Private Firms: Reporting, Financing, and the Aggregate Economy at the University of Chicago Booth School of

Business. https://www.sec.gov/news/speech/crenshaw-remarks-symposium-private-firms-041422.

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within the ETF asset class. Specifically, we investigate the types of ETFs traded by retail

investors as a group (i.e., where they invest their capital), the duration that those ETFs are held,

and the performance of those ETF investments by retail investors.

We identify retail‐initiated ETF purchases and sales using the approach in Barber,

Huang, Jorion, Odean, and Schwarz (hereinafter BHJOS, 2023). On each trading day, we

scale retail dollar volume in each ETF by total retail dollar volume in all ETFs to produce a

measure of relative fund popularity with retail traders (dollar volume weight, DVW).

Similarly, we scale net dollar volume (i.e., buy orders minus sell orders) by the sum of the

absolute value of net dollar volume across all funds to create a novel order imbalance

measure called the net dollar volume weight (NDVW). Prior measures of order imbalance

that scale by fund‐level trading activity are difficult to interpret in the presence of outliers

with low trading activity (Barber et al., 2023). In contrast, NDVW measures the relative

intensity of net trading (i.e., buying or selling) across funds and is also usable as a set of

portfolio weights for performance analysis. For comparison purposes, we construct similar

dollar volume‐and net dollar volume‐based measures from marketable trades initiated by

nonretail‐identified investors.

By dollar volume, retail investors trade similarly to nonretail investors overall, but with

some notable differences upon closer inspection. Across all funds, the average daily cosine

similarity between retail and nonretail DVW is 0.95 out of a maximum of 1.0, suggesting near‐

identical allocations of dollar volume by both investor groups.

7

However, differences are visible

at the fund category level. For example, retail traders allocate almost 13 percentage points more

dollar volume to complex ETF strategies like Leverage and Inverse funds than nonretail

traders, and comparatively less to more traditional fund categories like Core Equity. On

average, combined daily retail dollar volume in these complex fund types is 27% of ETF dollar

volume, nearly matching the dollar volume allocated to ETFs tracking the S&P 500, Russell

2000, and other Core Equity benchmarks. Heightened retail trading of complex ETFs

corroborates the SEC's concern that retail traders may be exposing themselves to investment

risks they do not fully understand.

When measured by net dollar volume, retail trading in ETFs appears quite different from

nonretail trading, as well as retail trading in stocks. The average daily cosine similarity between

retail and nonretail NDVW is very low across all ETFs (0.09) and remains modest within all

fund categories (<0.33). Retail net buying accounts for 69% of total absolute net dollar volume,

on average, versus 55% for nonretail net buying. The much stronger tilt toward net buying by

retail traders is consistent with relative limitations in retail ability or willingness to sell ETF

shares short. In multivariate regressions, daily retail NDVW persists from the prior day and

month, but only has a modest positive correlation with prior nonretail NDVW. Retail NDVW is

also positively related to prior‐day and prior‐month returns. This momentum‐like retail trading

behaviour in ETFs contrasts with the negative association between prior‐month returns and

retail NDVW in common stocks.

8

Our results suggest that retail investors consider past returns

differently when investing in ETFs versus common stocks, motivating further study of the ETF

asset class in the future.

7

See Sias et al. (2016), Barucca et al. (2021), and Girardi et al. (2021) for applications of cosine similarity as a measure of

investment portfolio overlap.

8

Prior studies also provide evidence of contrarian retail investing in stocks. For example, see Welch (2022), Boehmer

et al. (2021), and Kaniel et al. (2008).

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