Managing and avoiding ETF closures
Many have heard the term “ETF closure”, but few know what it means. According to the Investment business Journal, closure is a process where ETF providers withdraw their creations and listings from a marketplace due to a lack of investor interest, poor performance, or any other reason, usually after 12-24 months of inactivity.
In some cases, closures are unavoidable or out of an ETF’s control. In other cases, however, careful planning at the onset can help manage the likelihood that an ETF might close down. This article provides investors with strategies for avoiding and managing possible closures in the future while emphasising historical examples leading up to past closures.
What goes into closure?
When trading products go wayward in a hurry, ETF closures usually follow. In 2016 alone, there have been 15 global ETF closures and more than double that number in the US. As we saw back in 2015, not all ETF closures are permanent and many of last year’s closings returned within a few months to trading markets again.
The Proshares Ultrashort 20+ Year Treasury (TBT) is an example of such a case. Between October 13th 2015, and February 11th 2016, TBT was removed from trading by its issuer due to internal constraints resulting from new Commodity Trading Advisors (COTs) regulations. It would only take until May of the same year for TBT to return as a viable product after creating a new share class that adhered to the new regulations.
ETF Closure: Unavoidable or Controllable?
The unfortunate reality is that not all ETF closures are avoidable, and in some cases, it might be due to factors outside the fund’s control. However, in many cases, there are steps that issuers can take to help avoid a closure. Often it comes down to creating products with better trading liquidity and ensuring sufficient marketing and investor awareness.
For an ETF issuer to maintain a product on an exchange, Rule 19b-4 of the Securities Exchange Act stipulates that the product must have sufficient public interest. It’s determined based on several factors, such as average daily trading volume(ADTV), bid-ask spreads, and market capitalization. If an ETF issuer believes it can no longer meet the SEC’s Rule 19b-4 requirements, a closure may be the only option.
What Can Investors Do?
There are many things that investors can do to help avoid or manage an ETF closure. One of the most important is understanding how and why a particular ETF might be at risk for closure. Often, closures occur due to a lack of investor interest and poor performance. Knowing this, investors can allocate capital elsewhere if they feel that their chosen product is in danger of closure.
ETF providers usually give 12-24 months notice before a product closes, so investors generally have ample time to react. If an ETF is liquidated, the proceeds from the sale of the underlying holdings are usually returned to investors pro-rata.
Historical Examples: What to Avoid?
To give a few examples, many ETF closures in recent history have been due to low trading volume and wide spreads. In 2015, Claymore Investments removed 12 products from ETFdb.com due to “limited investor interest” and “significant redemption activity.” It was most likely a result of the market volatility at the beginning of the year.
Other closures have been due to a specific company or industry events that have made an ETF unviable. The Global X Lithium & Battery Tech ETF (LIT) provides a good example. This fund was closed in September of 2015 due to poor performance and the bankruptcy filing of one of its significant holdings, Albemarle Corporation (ALB).
As we see more and more ETFs hitting the market, thanks to advancements in these products by issuers and issuers alike, inevitably, some won’t make it. Being aware of this, however, can help minimise any harmful effects.
If an ETF issuer does decide to close a fund down, an investor’s best course of action is to react quickly before losing capital. As seen with TBT last year, sometimes closures are temporary, but investors should be wary as these occurrences may soon become more commonplace as product proliferation continues into 2016 and beyond.