Factor Capital Management, the managing owner of the FactorShares family of ETFs, recently announced the closure and liquidation of its five ETFs. Thursday, November 21, will be the last day of trading. These funds already have the highest expense ratios of all listed ETFs, and in addition to those fees, anyone holding shares after Thursday will incur the costs of closing the funds.
The affected funds and their 12-month breakeven expenses as of March 31, 2013:
- FactorShares 2X: S&P500 Bull/TBond Bear (NYSEARCA:FSE) 33.70%
- FactorShares 2X: TBond Bull/S&P500 Bear (NYSEARCA:FSA) 27.48%
- FactorShares 2X: S&P500 Bull/USD Bear (NYSEARCA:FSU) 17.66%
- FactorShares 2X: Oil Bull/S&P500 Bear (NYSEARCA:FOL) 25.22%
- FactorShares 2X: Gold Bull/S&P500 Bear (NYSEARCA:FSG) 9.68%
I had a favorable opinion of FactorShares when they launched in February 2011 based on their excellent educational materials and estimated investor breakeven costs ranging from 1.08% to 1.19%, including the 0.75% management fee.
Unfortunately, those estimated breakeven costs proved to be pure fantasy. Additionally, the real costs are hidden from most investors, as Morningstar and other prominent ETF analysts, reviewers, and data providers erroneously list the total expense ratios as 0.75%. Ned Davis Research and my own ETF Field Guide are two sources that attempt to reveal the actual expenses to investors.
The FactorShares ETF overviews and fund factsheets state a Management Fee* of 0.75%. However, the asterisk implies a footnote, and the footnote reads, “Other fees apply including brokerage commissions. See Breakeven Table in the prospectus for more information.”
Some people might think the “brokerage commissions” disclosure refers to the commissions incurred by investors buying the ETF, and therefore never bother to read further. Apparently, many ETF analysts fell for that gimmick.
However, anyone making the effort to read the Breakeven Table on page 25 of the prospectus (pdf) would quickly learn the FactorShares 2X: S&P500 Bull/TBond Bear (FSE) “is subject to (i) a Management Fee of 0.75% per annum, (ii) estimated brokerage commissions and fees of 0.28% per annum and (iii) routine offering, operational, administrative and other ordinary expenses of 32.73% per annum. This Fund is subject to fees and expenses in the aggregate amount of approximately 33.76% per annum.” The Fund also expects to earn 0.06% in interest income, which improves the breakeven rate to “only” 33.70%.
If you own these ETFs and don’t already feel fleeced by these high expenses, then don’t sell your shares so you can also bear the costs of closing the funds by having the expenses taken out of your liquidation proceeds. According to the press release, “Each Fund’s net asset value will reflect the costs of closing the Fund as calculated on the liquidation date.”
You could blame FactorShares for hiding these costs, or you could blame the analysts for not performing proper due diligence. However, in my opinion, the SEC is the party at fault for allowing this type of deceptive expense reporting to exist.
When an ETF’s total expense ratio is 33.70% and the SEC allows the fund to claim it as a 0.75% management fee along with a footnote that says to read the prospectus if you want to know more, then there is something wrong with the regulation of ETFs.
Thankfully, FactorShares are closing this week, and this blight on the ETF industry will soon be gone.
Disclosure: (Covering writer, editor, and publisher). No positions in any of the securities mentioned. No positions in any of the companies or ETF sponsors mentioned. No income, revenue, or other compensation (either directly or indirectly) received from, or on behalf of, any of the companies or ETF sponsors mentioned.