On May 1, 2009, Invesco (NYSE:IVZ) PowerShares Capital Management LLC announced that it would be closing 19 ETFs on May 18. Shareholders of record on May 18 will receive cash equal to the amount of the net asset value of their shares as of May 22. That cash value should include any capital gains and dividends left in the cash portion of investors’ brokerage accounts, according to PowerShares. While the shuttering of these 19 ETFs may not come as a surprise to some investors, especially in light of earlier ETF closings in 2008, they nonetheless change the landscape of the ETF world. Liquidity is an excellent indicator of viability in the ETF industry, but there is not a particular formula that dictates if, or how long, a fund will last if investor interest is lacking or waning. The closing of the 19 PowerShares funds this month provides an opportunity to sort through some of the ETF clutter and examine what can go wrong and why.
The incredible popularity of ETFs from 2007 to mid-2008 brought with it an onslaught of new, and often similarly themed, products to market. The unique way in which ETFs are launched has provided sponsors such as PowerShares and Claymore with the opportunity to launch multiple products at a time. This flood, however, has proved to be unsustainable, leading to multiple ETF closings across the industry. Despite the recent hit, PowerShares still remains a significant player in the ETF business, with a product line of 135 ETFs with assets of $25.8 billion as of March 31.
PowerShares President Bruce Bond addressed issues of liquidity and viability in his press statement May 1. “After carefully evaluating numerous factors including shareholder considerations, length of time on the market, asset levels and the potential for future growth, we proposed closing certain portfolios that have not gained sufficient acceptance with investors,” Bond noted. “We remain fully committed to the ETF industry and expect to offer new, exciting products in the months ahead.”
Of the 19 PowerShares products closing, a dozen are based on fundamental indexes created by Rob Arnott’s Research Affiliates. The PowerShares FTSE RAFI indices use fundamental values to rank securities in the FTSE Group indexes. Of the 12 FTSE RAFI funds closing, nine are U.S. sector based and three are niche international portfolios. Arguably, the nine domestic RAFI closings are not purely based on lack of average daily trading volume or performance. Four of the domestic funds, PRFS, PRFE, PRFN and PRFQ, have three-month average daily trading volumes over 20,000. Many of the funds have markedly outperformed the competition when viewed on a multiyear basis. The problem for these funds has been the competition, as more and more fund sponsors enter the domestic sector ETF fray. Vanguard, in particular, has been particularly aggressive in the launch of lower-cost ETFs. The competition has also prompted the Select Sector SPDRs, the sector ETF leader, to reduce their expense ratios, making them the lowest-priced sector ETFs in the marketplace.
In addition to the FTSE RAFI ETF closures, PowerShares is also set to close five of its Dynamic ETFs—a family that includes more than 40 funds. The Dynamic ETFs are quantitative-based indexing funds based off of the Intellidex benchmarks. The Indellidex approach takes into account fundamental, momentum and risk measures to weight products. Again, these closings are not necessarily directly related to trading volume or group affiliation. PowerShares Dynamic Asia Pacific (PUA) is being closed, while PowerShares FTSE RAFI Japan (PJO) will remain open for the time being. PUA and PJO both have average daily trading volumes in the 11,000 range.
The other two ETFs that PowerShares will be closing, PowerShares International Listed Private Equity Portfolio (PFP) and PowerShares High Growth Rate Dividend Achievers Portfolio (PHJ), are both perhaps too narrowly focused to gain traction. PFP and PHJ attracted $25.6 million in combined assets, with three-month average trading volumes of approximately 17,000 and 10,000, respectively. PFP launched during rather inauspicious times—late 2007, just as an economic meltdown was getting under way. PHJ launched in 2005.
While average daily trading volume is a good indicator of investor interest in the fund, another important factor is assets under management. Not all investors, however, are created equal. In order to determine the true public interest in an ETF, you have to view public investment interest separately from seed money when evaluating total assets. This is why assets under management alone can sometimes be deceiving. ETFs are created in large units of shares, typically 50,000 or 100,000. When an ETF is initially launched, the designated market maker will create a number of these units. The market maker then generally tries to sell off these units piecemeal, and when its inventory gets low, it creates additional units. Primary market makers generally do not redeem these initial units, and with low-volume products, they have to wait a considerable amount of time to move their seed investment. Low volume can lead to wider bid/ask spreads or lack of depth in the marketplace, forcing individual investors to often buy at marked premiums and sell at discounts.
Current investors in the 19 PowerShares products set to close face a decision in the next couple of weeks. The first option is to hold on to shares after May 18 and receive their May 22 value. The upside of this strategy is not having to sell shares into an illiquid market—or have to cash out at a large discount because so many others are doing so. The downside to holding shares until liquidation is that your investment will be tied up for a couple days as the fund closes. The last day you can sell the fund is May 18, and the value of your investment may change between the 18th and the 22nd while you are powerless to sell your shares. PowerShares also warned in its recent announcement that the closure process “will cause each fund’s holdings to deviate from the securities included in its underlying index and each fund to increase its cash holdings, which may lead to increased tracking error.” The funds closing, three of which are tracked by ETF Report, include:
- PowerShares Dyn Aggressive Growth (NYSE:PGZ)
- PowerShares Dyn Asia Pacific Portfolio (PUA)
- PowerShares Dyn Deep Value Portfolio (PVM)
- PowerShares Dyn Europe Portfolio (PEH)
- PwrShrs Dyn Hardw & Cons Electr (PHW)
- PwrShrs FTSE RAFI Asia Pac ex-Jpn Sm-Mid (PDQ)
- PowerShares FTSE RAFI Basic Mat (PRFM)
- PowerShares FTSE RAFI Cons Goods (PRFG)
- PowerShares FTSE RAFI Cons Serv (PRFS)
- PowerShares FTSE RAFI Energy (PRFE)
- PowerShares FTSE RAFI Eur Sm-Mid (PWD)
- PowerShares FTSE RAFI Financials (PRFF)
- PowerShares FTSE RAFI Health Care (PRFH)
- PowerShares FTSE RAFI Industrials (PRFN)
- PowerShares FTSE RAFI Intl Real Estate (PRY)
- PowerShares FTSE RAFI Telecom & Tech (PRFQ)
- PowerShares FTSE RAFI Utilities (PRFU)
- PowerShares High Gr Rate Div Achievers (PHJ)
- PowerShares Intl Listed Private Equity (PFP)