30 october 2019





DON'T END UP WITH A DEAD ETF IN YOUR PORTFOLIO




By Raul Elizalde

This article also appeared on forbes.com


DWS (the asset-management arm of Deutsche Bank) just announced that it will shut down five of their Xtrackers ETFs, or exchange-traded funds. They are DEMG (FTSE Emerging Comprehensive Factor ETF), DBKO (MSCI South Korea Hedged Equity ETF), DESC (Russell 2000 Comprehensive Factor ETF), IFIX (Barclays International Corporate Bond Hedged ETF) and IGVT (Barclays International Treasury Bond Hedged ETF).


This is just business as usual. ETF providers regularly try out new funds and shut them down if they fail to attract enough investor interest. DEMG, for example, had about $3.5M in assets under management after three and a half years of existence. With that size and at a 0.5% expense ratio, the ETF generated a mere $17,500 in yearly fees to the provider – much too small to cover the ETF’s compliance, reporting and management expenses.


This risk is specific to ETFs. While a stock can plummet if the company goes bust or the market tanks, an ETF can cease to exist even if everything else is going well. The key issue is the ability of the fund to grow and ensure its long-term viability. Often this has little to do with the size of the provider.


DWS, for example, is huge, and whatever losses it may have sustained by keeping those ETFs alive for a few years were probably quite small to matter much to the group’s bottom line. Giant asset manager Blackrock, owner of the iShares ETF provider, closed 6 funds this year and 18 in 2018. Even State Street Global Advisors, the manager of the largest ETF (SPY, which tracks the S&P 500 with $278BN under management) closed 19 funds in 2017. Invesco closed 18 so far in 2019.


One major attraction of ETFs is that they allow investors to reach almost any corner of the market efficiently, and this has been a main reason for their success. Markets that used to be out of reach for most retail investors such as illiquid high yield bonds, structured loans, currency-hedged international equity markets or any number of commodity areas can now be accessed as easily as a share of Microsoft.


But slicing and dicing markets segments can also get out of hand.


Consider NASH, the “LocalShares Nashville Area ETF” created to invest in companies based in the Nashville, TN area. The Music City is a wonderful place, but the chance that this ultra-niche ETF could prove as popular as its music venues was quite low from its very inception. Predictably, it closed on 2/9/2018.


Other narrowly-defined ETFs include DEMS and GOP, respectively the “Democratic Policies Fund” and “Republican Policies Fund.” Even in the highly partisan times we live in, neither overcame investor apathy and ended their runs on 4/24/2018.


A particularly obscure ETF was JUNE, the Dhando Junoon ETF that tracked the Dhando Junoon index (an index most investors never heard of). JUNE closed on 6/26/2017.


Not all ETFs that die out are that exotic. Many investors would find it reasonable to consider EMCR (Columbia Emerging Markets Core ETF), HDIV (Russell High Dividend Yield ETF) or WUSA (WisdomTree U.S. Domestic Economy Fund, focused on companies deriving most of their revenue in the U.S.). Alas, none survived.


What happens when an ETF provider closes a fund?


Investors generally receive a 30-day advance notice. The funds continue to trade in exchanges within that period, but their liquidity, presumably already quite low, tends to vanish. Bid-ask spreads widen, sometimes significantly. These two undesirable factors can lead to an ETF holder to sell at a significant discount from the fund’s intrinsic value. One way to avoid this is to wait until liquidation and receive full value, but that creates market risk – by then, the value of the underlying assets can fall.


When considering ETFs, investors should not rely solely on the reputation or staying power of the funds’ providers. It is also very important to pay attention to the funds’ ability to raise assets, especially for funds that target narrowly defined markets areas. This will lower their chances of finding a dead asset in their portfolios.


Questions? Talk to us.