There is no denying the popularity of ETFs. As we watch this market continue to grow, it’s only natural to see the unsuccessful funds fail along the way. This leads to ETF liquidation and investors worried about their money.
When an ETF closes, it’s not a guarantee you’ll lose money. The good news is there are steps you can take to avoid these unsuccessful ETFs and ways to deal with the liquidation process if it happens to you.
So why does an ETF get shut down? The same reason any fund does – a lack of invested money. There are several reasons for this, which happen to be the same reasons to avoid suspect ETFs:
- Small Category Focus – might have too small a focus or be too complex for most investors.
- Low Trading Volume – trading volume is a sign of popularity. A low trading volume brings liquidity risk and tracking errors.
- Low AUM (Assets Under Management) – profits are based on AUM. A high AUM is best.
- Poor Performance – an ETF that doesn’t perform inline with its underlying index 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 one or more of these, see how it compares to its competitors.
An ETF screen makes a comparison easy. Look at AUM first, then break it down from there. The ETFs with the higher AUM will have a higher trading volume, perform closer to the index, and probably have lower costs too.
It’s all about profitability. If the fund company isn’t making money, the ETF will be shut down.
When Your ETF Closes
After an ETF closes, any money left is paid out to the shareholders. You have a choice to make before that happens.
The ETF closing process works like this:
- An announcement is made one to four weeks before the ETF closing date. This gives you time to sell before trading is halted.
- Once the ETF is closed, it is delisted and all trading is stopped.
- When the ETF liquidation begins, the fund has about two weeks to sell its holdings and the cash is paid out to you or credited to you account.
If you’re caught with a closing ETF, you have two choices. You can sell the shares before the closing date or wait for the liquidation. Make sure you read through the announcement carefully. Sometimes a company only announces a delisting, where the shares will trade on the OTC market (over the counter), which is harder to sell shares at the price you want.
Consider This Before Selling
It’s easy to over react to an ETF liquidation. Nobody likes losing money, so the first thought is to sell immediately. It’s most likely the wrong one. Don’t get caught up in the headline fear because you won’t be the only one.
When a bunch of shareholders rush to sell, it only drives down the share price of the ETF. Its real value might be higher since the ETF is valued on the assets it holds (called net asset value or NAV). Too many sellers can push the share price below the value of those assets. When that happens, the best option is to use limit orders when you sell to get a price closer to the net asset value.
One thing to keep in mind is the assets liquidity. If the ETF is just a basket of popular stocks, selling those holdings will be easy. But what if the ETF holds illiquid assets? There’s no guarantee it gets fair market value, so selling the shares early is the better choice.
Every ETF liquidation is different. Make sure you read the prospectus thoroughly to understand the costs, expenses, and fees involved. A little research will go a long way to help you avoid unsuccessful ETFs in the future.