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By Jeremy Glaser | 11-10-2010 11:18 AM

Burns: Your ETF Won't Fail

Morningstar's Scott Burns takes a critical eye to recent reports on the dangers of ETFs.

Jeremy Glaser: For Morningstar.com, I'm Jeremy Glaser. Recently the Kauffman Institute released a report written by Harold Bradley on how ETFs could be a potential danger to the market and to the recovery as a whole. I'm here today with Scott Burns, Director of ETF Research for Morningstar, to take a closer look at this report and see if there is anything to it.

Scott, thanks for talking with me today.

Scott Burns: Jeremy, thanks for having me.

Glaser: So, what's your overall impression of this report?

Burns: Well, as a piece of research, I don't have a very high impression of this report at all. I mean, it's kind of a rambling diatribe that accuses ETFs of stunting the economic recovery to being the potential for future market collapses, and a lot of it uses – it's not a good research report in a good academic sense. I mean, there is a lot of selective examples taken, ignoring of contradictory evidence, and even just claims that are unsubstantiated, a lot of all, oh, I hear this from these people, and I'm going to call that a trend and call that research.

So, as a research report, I think, once you get pass the very incendiary executive summary, you will find that there is this very rambling kind of misconstrued piece of research contained in these 84 pages. And I think, what's really surprising and why people have picked up on it is that the author has what seem like extremely good credentials, and it looks and feels like a real research report. But as a researcher when you get into it, you start to realize that, that there are a lot of gaps in the analysis.

Glaser: Let's take a closer look at it then. One of the first things that's talked about is high frequency trading, and it's a defense of high frequency trading in a lot of ways. Is that something that you disagree with?

Burns: Yeah, actually, that part of the report, I agree with. I think, by and large high frequency traders are good for the market. I think, when we look at whatever money they are making and compare it to the grand amount of money that investors have saved over the past two decades as electronic trading has become more prevalent, the investors are actually coming out ahead. I mean, there is still a little bit of a skim that they are taking.

But when we look at bid ask spreads across the board and transaction costs, things have dropped dramatically. I think, what's most curious about the author's take on this is that while he is defending high frequency trading, he then kind of goes into this rant against dark pools of capital and follows that up with ETFs. As if high frequency trading dark pools of capital and ETFs are somehow separable items. I mean, they are a very symbiotic relationship between those things and the growth of high frequency trading. One, they need dark pools of capital with which to do that trading, and two, the ETF has helped to facilitate that and helped to really grow that market as well as a viable source. So, it's very kind of confusing argument of this is okay, but the things that they require are bad, so I don't really know how that jives.

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