How can you tell if an ETF won't last?

How can you tell if an ETF won't last?

How can you tell if an ETF won

Aside from their liquidity and transparency, one of the features that have made ETFs the darling of many a fund investor has been their tax efficiency. That advantage exists insofar as units can be created or redeemed without triggering a taxable event, along with the fact that a great majority of ETFs are passively managed.

But that tax efficiency can disappear under a certain set of circumstances, which includes fund closures. If a certain ETF is shuttered, it could cause a taxable event for those who are forced to sell out of an ETF when they weren’t planning to.

For that reason, and many others, it would be useful for investors to recognize the hallmarks of a dead fund walking — and that’s precisely what new analysis by CFRA has found.

An industry post-mortem
The firm arrived at the findings after it looked at the ETF universe that existed in December 2014, and studied how that population of funds did up to August 2019. As reported by WealthManagement.com, “[N]early a quarter (24%) of the 1,662 exchange traded funds that existed five years ago have closed down.”

The researchers also determined the number of funds that underwent four other types of changes over the past five years:

  • Rapid growth (>20% annual asset growth) – 25%;
  • Stable Growth (0-20% annual asset growth) – 21%;
  • Slow decline (0-20% asset decline) – 23%; and
  • Rapid decline (>20% annual asset decline) – 7%

Features of a zombie ETF
Focusing on the funds that underwent closure, the firm found that the top predictor is assets under management. According to Aniket Ullal, vice president of ETF data and analytics, the ETFs that closed had median assets of US$10 million in December 2014, and 89% never broke the US$100-million barrier, which many believe is the threshold for fledgling funds to achieve sustainability.

“There’s a whole range of ETFs that started out small and never got their traction to cross $100 million into viability,” Ullal told WealthManagement.com.

For many doomed funds, having a meager AUM put them in a vicious cycle.

“Brokerage firms will not allow advisors to buy an ETF that has too little in assets under management,” said Todd Rosenbluth, head of ETF and mutual fund research at CFRA. Such AUM thresholds are supposed to help brokers sidestep the headaches of a fund closure — which, ironically, becomes more likely for funds that don’t get distribution through a broker.

Another 34% of the funds that were shuttered were exchange-traded notes, which are index-linked unsecured debt securities. ETNs never took off with investors, Ullal said, because such products would require that they take on the credit risk of the issuer.

“Further, many ETFs that shut down were highly specialized international funds,” WealthManagement.com said. Those included the WisdomTree Asia Local Debt fund (ALD), iShares MSCI Eastern Europe fund (ESR) and Invesco Chinese Yuan Dim Sum Bond fund (DSUM).

 

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