Every now and then, a mutual fund will close to new investments, especially if it's performed exceptionally well. Success brings funds additional investors and additional dollars, leaving fund managers fewer appealing options for investing those dollars. Since less nimble funds risk poorer performance, managers close their funds to new investors, increasing the chances of better returns for their current investors. Strange as it may seem, fund closures are a good thing.
But when exchange-traded funds close, as 11 ETFs reportedly did recently? That's not so good.
In the past few years, ETFs -- combining the convenient trading of stocks with the broad diversification of mutual funds -- have skyrocketed in popularity. Investor demand has helped to launch many new ETFs, bringing the recent total to more than 500. As we've noted here in Fooldom, many ETFs have focused on extremely narrow niches, such as infectious diseases or the waste industry. The recent ETF closings, involving funds run by Claymore Securities, suggest that the industry may have gotten ahead of itself, opening more ETFs than the market needed or wanted.
The closings are also rather different from typical fund closings. These ETFs won't remain in existence, serving grandfathered-shareholders as closed mutual funds do. Instead, they're being liquidated, giving shareholders their money back -- whether it represents a gain or loss. This is far from ideal, since many investors intend to invest in vehicles such as ETFs for long periods of time. Selling ETFs creates a taxable event, and unplanned sales like these can lead to taxable gains and other unexpected ramifications.
In case you're interested, the 11 ETFs are Claymore's smallest and least popular funds. While they hold some well-known stocks, the closing funds appeal to niches that apparently didn't draw many customers. For instance, the Claymore/KLD Sudan Free Large-Cap Core ETF owns shares of Dell
In the ETF world, owning the right stocks isn't enough. You also have to have an appealing, easily marketed idea behind the fund. Since not every fund will succeed in that respect, expect more closures in the future.
Longtime Fool contributor Selena Maranjian does not own shares of any companies mentioned in this article. Dell is a Motley Fool Inside Value recommendation. Dell and Barr Pharmaceuticals are Motley Fool Stock Advisor recommendations. The Motley Fool is Fools writing for Fools.