Do More Trades Mean More Gains for ETF Investors?

The exchange-traded fund landscape has evolved significantly in recent years. In 2019, the SEC made it easier for new ETFs to enter the market, leading to a surge in ETFs that look a lot different from the market-cap-weighted index funds that once dominated the market. Today, the average ETF is more complex and faces higher portfolio turnover. Even though improvements in technology have driven costs lower, trading still has a cost, just one reason ETFs that trade more frequently tend to underperform their steadier peers.

Hard Work Doesn’t Pay Off

Consider a large set of US-domiciled equity ETFs with reliable turnover data divided into five buckets, or quintiles, based on their turnover ratio.

ETFs that traded the least did the best by a long shot. Those in the lowest-turnover quintile outperformed their average Morningstar Category peers by an average of 1.97 percentage points annualized over the past three years. After that, excess returns fall off. ETFs in the higher-trading quintiles charged higher fees, held fewer stocks, and performed worse compared with peers. The third and fourth buckets were underwater, and the ETFs that traded the most barely kept their heads above water.

The ETFs that landed in the top and bottom 1% of average turnover highlight what happens at the extremes. The 1% of ETFs with the lowest turnover had excess returns of 1.80 percentage points on average versus category peers. That group included popular index funds such as Vanguard S&P 500 ETF VOO and SPDR S&P 500 ETF Trust SPY, both touted for their low-cost tracking of the S&P 500. Market-cap-weighted indexes like these stay in balance as stock prices fluctuate, reducing the need to transact.

On the other end of the spectrum were ETFs with extremely high turnover ratios, ranging from 290% to 4,712% for the top 1%. These 12 ETFs’ excess returns were negative 2.85 percentage points on average. Vesper US Large Cap Short-Term Reversal Strategy UTRN (this fund closed on March 28, 2025, shortly before publication) and Pacer Lunt Large Cap Alternator ETF ALTL both stood out for the wrong reasons.

UTRN paired the highest turnover ratio from this dataset with an annualized excess return of negative 6.17 percentage points over the three years through year-end 2024. It buys out-of-favor stocks on the hopes they rebound. The index it tracks rebalances weekly and holds only 25 stocks.

ALTL tracks a rules-based index that rotates its holdings between the S&P 500 Low Volatility Index and the S&P 500 High Beta Index. It chases the index that will have better performance, evaluating and rebalancing monthly. Unsurprisingly, this leads to high turnover since the ETF swaps all its holdings if the index it holds is projected to underperform the other index. From February to March 2025, the ETF rotated its entire portfolio from the high-beta index to the low-volatility index. This ETF has failed to time the market consistently; it underperformed its average peer by 12.20 percentage points annualized from 2022 through 2024.

Performance in the highest-trading buckets isn’t all bad. However, investors should be aware of the risks associated with these ETFs. The variability in returns is much greater than the lower-trading buckets. Between the two highest-trading buckets, the best and worst three-year average excess returns were 23.72 percentage points and negative 68.07 percentage points, respectively, compared with 17.29 percentage points and negative 26.95 percentage points for the two lowest-trading buckets of ETFs.

Index Funds Are Not Immune

Index funds are usually seen as a safe bet, but that’s not always the case. While fewer index funds fell into the highest-trading buckets, they still made up the bulk of ETFs in every bucket.

The definition of an index fund hasn’t changed, but the indexes that funds track have strayed far from their origin. ETFs now track a slew of benchmarks far more complicated than straightforward, broad-market indexes such as the S&P 500. Fewer indexes are using market-cap weighting, and the number of stocks they hold has significantly declined on average. The aforementioned UTRN and ALTL are classified as index funds, but both had excessive turnover, high fees, and poor performance and track indexes that look nothing like the broad market.

Survival of the Slowest

Every year, new ETFs hit the market, and every year, ETFs die. The ones sent to the chopping block are typically smaller funds with poor performance. Many don’t make it past five years. It follows that funds in the higher-trading buckets, which tend to underperform peers, close at higher rates.

The funds that traded the most had the highest fees and, likely, the highest trading costs. Both weigh on returns and can drive investors out of the ETFs. The highest traded bucket saw 19% of its funds close; the lowest saw 12%.

Boring Is Better

Investors should be especially wary of equity ETFs that rely on high-trading strategies, even if they are index funds. Strategies showing strong back-tested results without a live track record (as many of these high-turnover funds do) tend to overpromise and underdeliver. ETFs relying on market timing, such as tactical asset allocation funds, trade more as they shift their position based on their projection of the future. Market-timing is incredibly difficult and nearly impossible to pull off in the long run. In 2024, tactical asset allocation ETFs underperformed each of their primary prospectus benchmarks by 4.96 percentage points on average.

It may not be glamorous to buy into a fund that rarely trades in and out of stocks. What’s even less glamorous is watching the rising tide lift all ships but yours. Costly ETFs cut into investors’ returns, necessitating superior performance just to stay even. Investing is one of the few cases where spending less gets you more.