Exchange traded funds continue to accumulate assets, gathering over $1.2 trillion in assets under management. Nevertheless, the highly competitive ETF business has forced funds to close and even entire ETF companies to throw in the towel as some investment ideas have not stuck with investors.
Most recently, FocusShares, a subsidiary of Scottrade, folded after failing to attract enough assets, bringing the ETF closure count up to 34 so far this year. Russell Investments is also conducting a "strategic review" of its U.S. ETF team, cutting about 30 jobs in the ETF unit, which does not bode well for the well-being of its suite of ETFs. Moreover, Direxion announced that it will close nine of its 3x leveraged products on Sept. 12 due to an "inability to attract sufficient investment assets."
"But for those concerned about ETF closures, perhaps there is an equally important criterion that should be considered, namely, which fund company sponsors the ETF in question," Ryan Issakainen, Senior V.P. and ETF Strategist at First Trust Advisors, previously wrote in a research note.
If funds do not gather enough assets, fund providers may not find it profitable to keep the ETF. However, larger companies with deeper pockets may patiently wait it out until a fund becomes popular enough to generate sustainable profits.
According to the ETF Industry Association, there were 1,486 ETF and exchange traded note products available, with $1.21 trillion in assets under management, as of the end of July, compared to the 1,295 ETPs, with $1.11 trillion in assets, at the end of July 2011. The ETF industry is dominated by the top three providers, BlackRock iShares, State Street Global Advisors and Vanguard, with a combined $1.0 trillion in assets.
However, with so many new investment products coming out, there are bound to be some losing ideas.
Like mutual funds, ETFs may fall under duress if it can no longer validate the expense of operations through investor fees. As an ETF loses assets, the fund will lose investors, increasing the cost of operating per investor. If the fund is not able to recover the lost interest, it may have to close down. Nevertheless, the closing of an ETF is an orderly and efficient process, and investors are given plenty of warning so they can act accordingly.
Before providers close the shutters on their ETFs, investors are notified three to four weeks prior to the stop date, and in the meantime, the ETF will still operate as usual during normal trading hours. In the event a firm shuts down an ETF, investors have one of two choices: sell your position before the final trading date, or wait for the fund to close and the check to come in. This can create tax consequences, and no investor likes surprises.
Obviously the delisting process is undesirable for the investor as he or she wanted to exposure to the position to begin with. Once the ETF is shut down, an investor would incur additional expenses, like commission fees, along with unwanted tax consequences. An ETF investment that was intended as a long-term holding may trigger a sudden tax bill if it is liquidated since the proceeds are distributed to investors.
If investors want to control when they are out, it might be better to sell the shares before the ETF stops trading. Investors should note that in the last days of the ETF, sellers will be scrambling to dump their positions, which can lead to hefty losses - due to the disparate number of sellers to buyers, the bid/ask spread tend to widen. Potential sellers should try to set up limit orders to sell at a given price so that one won't get caught unawares.