Nobody likes to see someone or something die before its time. But in the case of ETFs, a surprising number of weak funds may be holding on and refusing to shut down this year -- to the detriment of investors.
According to recent data from Morningstar, almost half of the 1,300 exchange-traded funds on the market have less than $50 million in assets -- typically the minimum for an ETF firm to turn a profit -- and that was before the August market turmoil. Yet only a handful have been shuttered so far in 2011, compared with at least 50 a year for the past three years, prompting many analysts to suggest that some funds are sticking around when they should close down. Indeed, Ron Rowland, an Austin, Texas, money manager who compiles an ETF-deathwatch list at Investwithanedge.com, estimates that more than 150 funds are on life support, not generating enough gains or interest to justify their continued existence. He says the pros who created these products are "in denial."
A lot of that denial, critics say, is the byproduct of managers launching ETFs almost weekly to try to jump on what's been a booming bandwagon. To their credit, some funds do close: A spokesperson for Invesco PowerShares Capital Management, an ETF company in Wheaton, Ill., says the firm recently closed two ETFs after reviewing several factors, including "investor interest." J. Garrett Stevens, chief executive of FaithShares in Oklahoma City, says the firm liquidated all five of its Christian-oriented ETFs this year because they "didn't have the brand recognition" to attract enough assets.
Analysts say a lot of other funds should consider the same path. When ETFs close, investors generally aren't hurt, because they're given time to cash out. If they do hold on until the end, investors will get back the cash value of the shares on their final trading day. But even if ETFs don't close, investors might not get the best prices on these thinly traded products. In the worst-case scenario, there may be no bidders. Indeed, no one bought or sold three iPath exchange-traded notes in June, the Pure Beta Aluminum ETN, the Pure Beta Copper ETN and the Pure Beta Industrial Metals ETN. All three have around $5 million in assets. A spokesperson for Barclays Capital, which creates iPath products, says the company takes a "long-term approach" to product development.