By Robert Goldsborough
With just weeks left in 2012, several records, of sorts, look like they will be set in the area of exchange-traded product launches and closures.
Totaling up all the exchange-traded funds and exchange-traded notes that have already closed this year and adding those that are scheduled to close before the end of December, we see that at least 95 ETFs and ETNs will end up shuttering in 2012. That would make 2012 far and away the Year of the ETF Closure.
What's more, while the number of ETF and ETN launches thus far in 2012 (165) still far exceeds the number of closures, we find it instructive that this year will end up with the second-fewest new launches in at least six years. Only in 2009, when the financial crisis gave ETF issuers tremendous pause, did fewer (136) ETPs begin trading.
ETF Industry Maturing?
For most investors, the biggest question to ask isn't about the magnitude of the ETP closures, as most ETFs and ETNs that close tend to be small, thinly traded products. Instead, when considering the increasing number of ETP closures, a declining number of new launches, and the widely publicized fee war going on at the broad beta end of the exposure spectrum, it's more reasonable to ask: Is the ETF industry simply maturing?
We would say the answer to that question is, in a word, yes.
It's All Relative
No one would dispute that the ETF industry is continuing to grow. Our data show that assets are continuing to flow into ETFs, with just over $139 billion flowing into U.S. ETFs for the year to date through Oct. 31. Furthermore, some new launches--most notably PIMCO Total Return ETF (NYSEARCA:BOND)--have been tremendously successful.
So from our standpoint, these signs of maturation are hardly heralding a decline just around the bend. But it does mean that the days of ETP issuers floating gimmicky products in a rising tide are nearing an end. In addition, we believe the current wave of closures indicates that exchange-traded product providers aren't anywhere near as willing to prop up money-losing funds as they have been in the past. The amount of assets needed in an exchange-traded product for an issuer to break even varies widely depending on the issuer, but let's assume that it's somewhere between $25 million and $75 million. As of Nov. 16, out of 1,445 U.S. exchange-traded products currently trading, some 684 had assets below $25 million. Expanding the field a bit more, we see that a whopping 823 exchange-traded products had assets below $75 million.
Closures are a natural part of the weeding-out process that will continue as the industry matures. Let's compare the 95 ETF and ETN closures already in the books (or scheduled) for 2012 with the 291 distinct U.S. open-end mutual funds that have closed thus far this year, through Nov. 19. With 1,443 U.S. exchange-traded products at present, that means that the industry lost approximately 6.5% of its exchange-traded products this year. That's a lot higher than the 2.7% of U.S. exchange-traded products that liquidated in 2011, for example. But, it could well be the sign of a maturing industry that is thinning out excess products. For perspective, when we look at a more mature investment product industry--the world of U.S. open-end funds--we see that the 291 open-end funds that were liquidated or merged away this year represent roughly 4% of the total number of separate open-end funds.
Beyond the Big Family Closures, a Surprising Amount of Diversity by Issuer
Much of the attention on ETF closures has rightly focused on big fund family closures. This year Russell shuttered 25 of its 26 ETFs, leaving its actively managed Russell One Fund (NYSEARCA:ONEF) as its lone remaining ETF, while FocusShares shuttered its entire suite of 15 low-cost ETFs. In both cases, the fund families' offerings struggled to gain traction with investors. Russell's funds were largely "smart beta"-type ETFs, and while the ideas themselves were interesting and academically sound, investors largely passed on them. FocusShares, by contrast, focused on U.S. equity sector ETFs. And while its funds had very low price tags, FocusShares learned that U.S. investors were content with the existing lineup of sector equity products from entrenched competitors iShares, Vanguard, and State Street.
Beyond the Russell and FocusShares closings, however, one sees a broad amount of diversity by ETF issuer across the remaining closures. UBS liquidated 12 of its 13 volatility ETNs. Known for trying a large number of ideas and being willing to pull the plug on them if they don't work, Global X closed eight ETFs. A smattering of closures came from a wide range of other providers, including Direxion, AdvisorShares, QuantShares, WisdomTree, IndexIQ, ALPS, and Guggenheim.
Below is a table showing the number of ETFs and ETNs closed or scheduled to close in 2012, by provider:
In the Closures, Trends Elusive
It's hard to discern any particular commonalities among 95 ETFs and ETNs to close in 2012. If anything, what's most striking is how diverse the product set is. In the list of closures, one can find currency funds (WisdomTree), volatility-themed ETNs (UBS and Barclays), triple leveraged (and triple-inverse) agribusiness ETFs (Direxion), a broad large-cap growth fund (WisdomTree), a broad capitalization-weighted range of ETFs (FocusShares), U.S. equity sector ETFs (FocusShares), hyper-niche sector ETFs (Global X), smart beta funds (QuantShares, Russell), an actively managed fund (AdvisorShares), single-country funds (IndexIQ), and even an oil and gas explorers ETF (ALPS).
Perhaps what is most noteworthy is what's lacking from the list of closures. Commodity ETFs, precious metals funds, and fixed-income ETFs are nowhere to be found. What's more, almost none of the funds being closed had income as a major selling point.
Other Reasons for Closures?
To be sure, while the vast majority of ETFs and ETNs this year have closed because of thin trading volumes and minimal asset levels, there have been other related reasons for closures. In some cases--such as was the case with Russell--providers have simply made a strategic decision to move away from issuing ETFs (at least for now). How can we say this with confidence? Because it's clear that some of Russell's ETFs may well have been viable and profitable--or at least, were heading to profitability. In fact, at the time of its August announcement that it would close and liquidate 25 ETFs, its largest ETF had $63 million in assets--which would be at or at least close to break-even for an issuer.
But ultimately, driving the thin trading volumes and minimal assets of the shuttered ETFs and ETNs is a lack of interest on the part of investors. Whether because a liquidated ETF sliced the onion too thinly or was just an undifferentiated product in a crowded field, what almost all of the shuttered ETFs have in common is that investors voted with their pocketbooks, placing their money elsewhere.
Not the Beginning of the End; Perhaps, the End of the Beginning?
In our view, the heightened number of closures isn't a bad thing for the industry and by no means represents the beginning of the end of the ETF industry. Instead, it likely signifies the end of the beginning, as Winston Churchill famously said.
What do greater numbers of ETP closures mean for investors? In the short run, we think it helps to consolidate liquidity into fewer products, and we see that as a good thing for investors. In the longer term, we think the acknowledgement by ETP issuers that growing numbers of product ideas haven't worked should be a warning sign to be more intentional about future product launches. Finally, we think increasing numbers of ETP closures signal a tacit admission by issuers that the broad beta end of the market is saturated, and increased price competition in this segment is here to stay. For investors, that can only be a good thing.
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