The popularity of exchange-traded funds has hardly wavered, even through the depths of the bear market. As a result, you can seemingly find a new fund anywhere you look. But in a sign of the times, some ETFs have decided to pull the plug after failing to attract a big following from investors.
A major provider of exchange-traded financial products, Invesco PowerShares, announced earlier this month that it would liquidate 19 of its ETFs. The closing funds include:
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ETF
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Assets Under Management
|
1-Year Return
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Holdings Include...
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|
PowerShares Dynamic Aggressive Growth (PGZ)
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$4.6 million
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(41.8%)
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Dolby Labs (NYSE: DLB ) , Apple (Nasdaq: AAPL )
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|
PowerShares FTSE RAFI Energy (PRFE)
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$9.8 million
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(40.6%)
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ExxonMobil (NYSE: XOM ) , Chevron (NYSE: CVX )
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|
PowerShares High Growth Rate Dividend Achievers (PHJ)
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$12.3 million
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(39.4%)
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Wells Fargo (NYSE: WFC ) , Pfizer (NYSE: PFE )
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Source: Invesco PowerShares, Morningstar.
As you can see, although the funds span across the spectrum of market sectors, none of the ETFs has a huge amount of assets under management. Although the 19 liquidating ETFs make up nearly one-seventh of the fund company's 135 ETF offerings, their combined assets add up to less than 1% of the amount that the company manages.
What's going on?
The closing of these funds isn't as bad as it sounds. Once a closing fund stops trading -- today is the last day for the 19 PowerShares funds -- the fund liquidates its assets, and shareholders eventually receive the value of their proportional share of those assets in cash. So while a shareholder may realize a gain or a loss -- along with any tax implications that go with it -- it's not as if investors lose everything just because the fund closes.
In fact, in many ways, it's heartening to see fund companies starting to pull the plug on some of their less successful funds. Like any other business, fund companies have to evaluate the potential market for a given ETF before they release it. With a significant amount of fixed costs involved in establishing and maintaining a fund, fund companies only earn significant profits once funds grow beyond a certain point.
For example, just take a look at the gross revenue produced by some of the most popular ETFs, based solely on their published expense ratios:
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ETF
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Assets Under Management
|
Expense Ratio
|
Gross Fee Revenue
|
|
SPDR Trust (SPY)
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$60.7 billion
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0.09%
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$54.6 million
|
|
PowerShares QQQ (QQQQ)
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$13.4 billion
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0.20%
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$26.8 million
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iShares MSCI EAFE (EFA)
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$27.3 billion
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0.34%
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$92.8 million
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Source: Morningstar.
By contrast, the tiny funds that PowerShares has decided to close are generating less than $100,000 per year in gross revenue -- almost certainly insufficient to pay for their expenses, much less turn a profit.
What you should do
Now that the ETF market has matured somewhat, new entrants are realizing that first-movers in ETFs have established a huge competitive advantage by building up their assets under management. Not only are older, larger ETFs more profitable than new competitors, but they also have a number of other attractive characteristics to traders, including tighter bid-ask spreads that reduce transaction costs.
Moreover, just like buyers and sellers who use eBay (Nasdaq: EBAY ) grow accustomed to the marketplace, becoming less likely to jump ship even if a competitor offers greater benefits, ETF investors rely on the liquidity and familiarity of particular funds. So even as funds with lower expense ratios or innovative ways of tracking benchmarks have debuted, the tried-and-true ETFs have nevertheless held onto most of their assets.
If you're interested in a particular ETF, keep an eye on the amount of assets it has under management. The greater a fund's assets, the better the odds that it will be able to lower its expense ratio, saving you money over the long haul. In contrast, if a fund's assets stagnate or start to shrink, consider it a warning sign that your ETF may not survive much longer.
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