There is no denying the popularity of ETFs. As we’ve seen the ETF market grow, it’s only natural to have a few unsuccessful funds fail along the way. This leads to ETF liquidation and worried investors. Which never sounds good when it’s your money.
When an ETF closes, it’s not a guarantee you’ll lose money. The good news is there are steps investors can take to avoid these unsuccessful ETFs and ways to deal with the liquidation process too.
So why does an ETF get shut down? There are several factors that can all be viewed as reasons to avoid certain ETFs:
- Small category range – watch out for the specialized and exotic ETFs.
- Low trading volume – trading volume is the sign of popularity, the higher the better.
- Low assets under management – profits are based on the asset amount. The higher the better.
- Low performance – an ETF that doesn’t perform up to investor standards won’t last long.
- ETF age – how long has the ETF been around? Newer isn’t always better.
If you come across an ETF that meets this criteria, see how it compares to similar ETFs. For instance, if you find one with significantly higher volume, it should have a lower chance of closing.
Eventually it comes down to profitability. If the fund company isn’t making money, the ETF will be shut down.
When Your ETF Closes
When an ETF closes, it’s not the end of the world for your money. It is best to weigh your options before taking any action.
The ETF closing process is fairly simple:
- An announcement is made one to four weeks before the ETF closing date. This gives investors time to sell before trading is halted.
- Once the ETF is closed, it is delisted and all trading is stopped.
- Then the ETF liquidation begins. The fund has about two weeks to sell its holdings and the cash is paid out to shareholders or credited to their accounts.
If you’re caught with a closing ETF, you have two options. You can sell the shares before the closing date or wait for the liquidation. Depending on the circumstances, there are benefits to both.
It’s easy to over react to an ETF liquidation. Nobody likes losing money, so selling is the immediate response. It might be the wrong one. It’s easy to get caught up in the headline fear. And you’re probably not the only one.
So a bunch of shareholders rush to sell only to drive the share price down. Except the ETF should be valued based on the assets it holds (called net asset value or NAV). Too many sellers and the share price can drop below the value of those assets. The best choice is to wait till liquidation or sell if the share price equals the net asset value.
One thing to keep in mind is the assets liquidity. If the ETF was just a basket of popular stocks, selling the holdings will be quick and easy. But what if the ETF holds illiquid assets? It will be difficult to get fair market value. So selling the shares early is the better option.
Every ETF liquidation is different. Make sure you read the prospectus thoroughly to understand the costs and expenses involved. A little research will go a long way when you invest in ETFs.