Record number of ETFs shutting down

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The explosive growth in exchange-traded funds is running into a new trend: closures.

A record number of ETFs will shut down this year in Canada and the U.S. as providers slam the door on funds that have failed to attract interest.

Investors may not miss such specialty offerings as the recently deceased Global X Fishing ETF (a play on fish-related products) and FocusShares ISE-Reverse Wal-Mart Supplier ETF (a way to bet on companies that sell to the world's biggest retailer). But the recent spate of shuttered funds is raising concerns the once seemingly insatiable appetite for new ETFs is finally hitting a limit, especially for niche players.

Some delisted ETFs came from providers "throwing spaghetti on the wall to see what is going to stick," said John Gabriel, an ETF strategist with Morningstar Inc. "They learned the hard way that it is not so easy."

The number of ETFs has boomed in recent years as providers have rushed to provide ever more specialized ways to play the market, ranging from funds that invest in smartphone-related companies to ones that focus on lithium producers.

New ETFs are still coming onto the market, but the pace of introduction is slowing and the wave of recent closures suggest that investors may be growing sated.

In the United States, 71 ETFs have already thrown in the towel this year or are set to close. Russell Investments, which will pull the plug next month on 25 ETFs, and discount broker Scottrade, which liquidated its 15 FocusShares ETFs last month, are getting out of the business altogether.

Scottrade's offerings had cheaper fees than Vanguard Group Inc., the usual low cost leader, but still couldn't gain traction after launching in March, 2011. "It's very cutthroat," Mr. Gabriel said. "Maybe some of the competitors on the fringe don't realize the stranglehold that the iShares, Vanguard and State Street ETF providers have on the [U.S.] market."

In Canada, eleven ETFs have already closed this year or announced they are closing. Most are products from Horizons Exchange Traded Funds Inc.,which will pull the plug on four offerings next month, bringing its total to 10 closures this year.

"Unfortunately, not all are going to be winners," said Horizon's chief executive officer Howard Atkinson. "It's no different from the mutual fund industry… If you look at the ETFs that are closing, the vast majority have less than $10-million in assets."

Horizons is closing the ETFs that have failed to spark interest among investors, usually because they have performed poorly in tough markets, he said. For instance, the $1.7-million Horizons GMP Junior Oil and Gas ETF closed last month after suffering a 41-per-cent loss since it was launched 18 months ago. "It's pretty hard to make an economic case to keep it open, especially when we have about 85 ETFs..."

Ron Rowland, president of U.S.-based Capital Cities Asset Management, said that the number of funds on his monthly "ETF Deathwatch" sits at a record 293, the highest level since he began tracking the U.S. ETF sector in 2008. The list, which is available on investwithanedge.com, includes ETFs that have been trading for more than six months but that have had less than $5-million (U.S.) in assets for three consecutive months.

While ETFs that don't attract significant money are clearly in danger of folding, there is no way to predict the demise of any single fund because some firms decide to subsidize lagging funds for a protracted period, said Mr. Rowland. "The closures often come in waves. One theory is that it is easier to hide your closures when everyone else is doing it."

The most recent wave of closures raises the question of whether investors should buy brand new ETFs. The largest risk is not that certain ETFs may close in the future, but rather "that they suffer from extremely poor liquidity today," he suggested. For investors that means potential difficulty in easily selling ETFs.

John DeGoey, an associate portfolio manager at Burgeonvest Bick Securities, is a fan of using ETFs for his client's portfolios, but usually sticks with ones run by big players like BlackRock Inc., Bank of Montreal and Vanguard.

"I don't think that you will see those firms launching funds that ultimately will close because all of them would risk a loss of reputation," he said. "For the smaller players, I would wait for the product to be around for three years, and become one of that firm's largest products."

Pat Chiefalo, an ETF analyst at National Bank Financial, acknowledged that investors could face a potential taxable gain or loss from unexpected closures, but says ETF closures reflect a "natural pruning process."

"ETF closures are the noise around the main show, which is the growth in the space," he said. "The new funds that have come on the market dwarf the ones that have closed."

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New ETFs vs. closings

Note: Canadian ETFs include only the main class.

Assets for 2012 as of Sept. 12.

*Closed ETFs do not include ones slated to be shuttered.

Source: Morningstar Inc.