Are we seeing an ETF zombie apocalypse?

We ask what the shuttering of 10 ‘zombie’ funds means for the ETF market

Despite each fund posting gains this year, BlackRock Inc. last week announced plans to imminently shutter 10 of its exchange-traded funds. The asset management giant has found that despite performing well, the funds are simply not that popular with investors. Exchange-traded funds that struggle to attract trading activity have been given the name “zombie ETFs”, but for one industry insider, the news did not come as much of a surprise.

“Over the years, we’ve all seen Mutual Funds be closed or amalgamated with a similar fund, why would ETFs be any different?” says Sean Harrell, Partner & Senior Advisor at Howe, Harrell & Associates.  “If there isn’t enough interest in an ETF to attract a certain amount of assets, a company will drop it and reallocate the capital needed to run that ETF regardless of performance.”

Stats show that less than $30 million was invested into each of the condemned ETFs, which is not enough capital for a provider to turn a profit. “The Emerging Markets Latin America ETF that is being closed was up 32% YTD (as of July 31, 2016) and down 33% since inception in 2013,” Harrell says. “People tend to invest on past performance, sometimes to their detriment. It’s hard to invest in a volatile market especially after a few rough years. I think, in this case, three years ago was just bad timing to launch an ETF representing Latin America’s Emerging Markets.”

Most ETFs that gain the doomed ‘zombie’ status are invested in niche markets, and Harrell believes that mainstream investors may not have the knowledge to understand these particular markets, or that the represented market is too volatile. “If a client doesn’t understand how the product will benefit them it is near impossible to get them to invest in it, especially if it is a volatile market,” Harrell says. “And in the case of the Emerging Markets Latin America ETF, I would bet that its short, lackluster track record hurt its chances of gathering new assets.”

Although he doesn’t believe the shuttering of the 10 Blackrock funds will have much impact on the wider ETF market, Harrell does think that the amount of ETFs currently in the marketplace makes it difficult for new offerings to make their mark. “Really, if you have one reputable ETF representing the TSX, how many other ETFs do you need representing the TSX?” he says. “It’s not like managers make a difference in ETFs like they do in Mutual Funds; you’re buying the index.  So, if you are late to the party and launch a new ETF that has already been represented in the market place for a couple years, I would think it will be difficult to attract new assets.”