The Fall of NETS ETFs: Good 'On Paper' Not Good Enough

by: Don Dion

On January 27, Northern Trust Corporation bowed out of the ETF business, closing 17 funds and heightening the anxiety of many ETF investors who had watched a handful of other ETFs shut their doors in 2008. When the ETF Report profiled the Northern Exchange Traded Shares (NETS) funds after their debut in May, we raised this question: while “the differences (that make the funds unique) may be significant for the hedge funds and institutional traders that typically deploy sophisticated hedging strategies or trade in large blocks of shares, how important are they for individual investors?” The methodology of the NETS ETFs was apparently not different enough to keep the brand afloat or attract the critical mass of assets needed for survival. While the 17 ETFs shuttered by NETS may have looked good “on paper,” their eventual downfall underscores many of the realities of ETF investing, which, in a leaner, meaner marketplace, investors will have to come to terms with quickly.

The Chicago-based trust bank launched its first 14 ETFs in May of 2008, entering the already crowded field of international ETF choices. Aside from one sector fund, the NETS Tokyo Stock Exchange REIT ETF (JRE), and one global index fund, the NETS FTSE CNBC Global 300 Index Fund (MYG), the NETS ETFs were aimed at regional stock exchanges in individual countries. While iShares’ line of country- specific ETFs is based on slices of the larger MSCI Index, NETS ETFs projected that the use of local indexes would add both arbitrage and liquidity opportunities for traders.

Unfortunately, the arbitrage opportunities provided by ETFs such as NETS France CAC40 Index Fund (NYSE:FRC) and the Germany-based DAX Index Fund (DAX-OLD) were not significant enough to attract volume from the trading community, which had been utilizing country-specific ETFs from other issuers for more than a decade in international trading. The liquidity in regional indexes also did not translate into liquidity for the ETFs representing them—when Northern Trust Corp. announced that the funds would be closing, the total combined assets for the ETFs were only $33 million.

One factor working against Northern Trust was the already crowded field of big-name issuers like Barclays’ iShares. While Northern Trust was the first issuer to file for a global ETF index with MYG, both Vanguard and iShares beat NETS to the pass, issuing their own global ETF index funds before MYG came to market. Other NETS funds found themselves directly pitted against other, better-known funds from the first day of trading.

The first two funds launched by NETS, the NETS FTSE 100 Index Fund (LDN) and the S&P/ASX 200 Index Fund (AUS), faced two entrenched predecessors. LDN faced competition from the iShares MSCI UK Index (NYSEARCA:EWU), while AUS faced the iShares MSCI Australia Index (NYSEARCA:EWA)—both iShares funds having been in existence from nearly the dawn of the ETF era in 1996. With $500 million and $430 million in assets, respectively, EWA and EWU each have many times the assets that the entire line of NETS ETFs held collectively at their closing.

Northern Trust officials cited “the inability of the funds to attract significant market interest since their inception” and current market conditions as the primary reasons for the closings. NETS officials also acknowledged that it was “advisable and in the best interests of the funds and their shareholders to liquidate the funds.” Those invested in the funds stand to face a couple of challenges as they await liquidation. NETS investors now have until Monday, February 9, to sell their shares in the open market. If shareholders choose to hold on to their shares, they will receive the underlying value of those shares (NAV) as calculated on January 20. During this time gap, from February 9 to 20, if investors still own shares, they will not be able to sell them and will have to wait to see what they are worth on the 20th. Because some investors do not want to face this uncertainty, it is likely that at least some of the funds will begin trading at discounts to NAV. Therefore, investors also may not be as concerned about getting fair value for their shares when bailing out of the funds before February 9. Holders as of the delisting date will receive a cash distribution equal to the net asset value of the shares as determined on February 20, the formal liquidation date.

In our June 2008 NETS feature, the ETF Report concluded that “in terms of holdings, the new Northern Trust ETFs and their iShares competitors just may not be different enough under the surface to matter to most do-it-yourselfers.” This standard is a valuable one for investors to consider as they select potential ETF investments from the increasingly larger pool of opportunities. It is not enough for an ETF concept to simply look good “on paper” or make sense conceptually—each new ETF brought to market must attract the assets and interests of a now-wary public in a leaner, more competitive ETF marketplace.