Exchange-traded funds (ETFs) have altered the global financial industry by providing investors with convenient access to foreign markets and a wide range of sectors.
However, the increased churn in the ETF market is a natural consequence of such rapid expansion. Some ETFs prosper, while others fail and have to be liquidated or delisted.
Although the process of formation and closure represents the constant change of a healthy market, investors are best off avoiding the scary stuff at all costs.
The year 2020 saw more than 7500 different ETFs offered in all. Of these 7500, nearly 300 ETFs closed from 2020 until February 2022, almost 4%!
Thus, it becomes very imperative for us to study the effects of ETF liquidation and closure.
What happens when an ETF closes?
An ETF can be closed in two different ways; one is liquidation and the other by delisting. We will see this in detail below. A prospectus supplement will indicate the ETF’s last trading date and liquidation date once the decision to disband the ETF has been finalized.
“Business as usual” ends at this time or soon after, and the fund stops making new investments as it proceeds to liquidate. As a result, the performance of an ETF diverges from that of its benchmark index.
During this time, the ETF issuer will continue to publish an indicative net asset value (iNAV) during the day, which is used when purchasing or selling the ETF. It’s generally a good idea to sell any shareholdings before the end of the trading day.
What is liquidation?
Investors receive cash payments equal to the NAV whenever an asset is liquidated. Most of the time, this has the advantage of offering you fair value for your shares.
Liquidation is vital to investors since they only have two weeks to liquidate their shares once the process starts. Once investors learn that their ETF is in the process of liquidation, they have two choices: selling before the closing date or waiting until the final liquidation.
To determine the best course of action, one must read the final prospectus supplement. Liquidation is generally less expensive and time-consuming than delisting the ETF if the issuer decides to do so.
What is ETF Liquidity?
What is delisting?
Delisting is significantly more time-consuming for investors who fail to liquidate holdings before the last trading day.
When this happens, they must trade OCT, i.e., over the counter, which is time-consuming and often costly compared to buying and selling on an exchange.
That is why delisting is vital to investors; failing to keep track of the closing date might negatively affect your investment portfolio.
Some examples of ETF closures are
| Date | Fund | Ticker |
| 3/7/2022 | Xtrackers Eurozone Equity ETF | EURZ |
| 1/14/2022 | Direxion Dynamic Hedge ETF | DYHG |
| 12/23/2021 | Credit Suisse FI Large Cap Growth Enhanced ETN | FLGE |
| 12/15/2021 | iShares iBonds Dec 2021 Term Corporate ETF | IBDM |
| 12/15/2021 | Invesco BulletShares 2021 USD Emerging Markets Debt ETF | BSAE |
Negative impacts of ETF closures
Impact on investors: Investors face at least four chief risks when an ETF is closed, i.e., liquidated or delisted.
Reinvestment Risk: The investor must now find a new investment avenue after cashing out of the delisted or liquidated ETF. It is an intrinsically risky undertaking, especially considering the opportunity cost of exploring new investment alternatives and their benefits and drawbacks.
Added Expenses: A delisted ETF incurs additional OTC costs for investors. Additional charges are charged when starting a new investment, which may have a fee structure that differs from the earlier one.
Loss of ETF Value: While the investor didn’t walk away with anything, it’s doubtful that he achieved the investment goals in the case of closure. Investors don’t choose ETFs they think will fail in the future. Investors face value loss that they must up elsewhere.
Tax Burden: One of the most significant downsides of ETF closures is an increase in the tax burden due to unanticipated capital gains.
Impact on Issuer: The major disadvantage of closure for an issuer is the danger of losing its reputation.
Reputation Risk: An issuer whose fund is liquidated or delisted may have a difficult time attracting new investors in the future. Advisors are less inclined to endorse ETFs from issuers with a history of closing funds for various reasons.
Ways to predict which ETF may be vulnerable to closure
1. Low AUM: One of the best predictors of closure risk is a low AUM. After all, funds that manage millions of dollars in assets are far too profitable to shut down.
2. Issuer strength: Look for ETFs sponsored by prominent, well-known companies such as iShares, State Street, Vanguard, Invesco, and First Trust. A minor sponsor may find it more difficult to continue operating an ETF if it does not initially attract assets.
3. Fund ranking: Less popular ETFs are more prone to closure; avoid them!
4. Trading volume: ETFs actively traded are more likely to change at the underlying assets’ value.
5. Appeal: Look for ETFs with a broad investment approach, such as S&P 500 index funds, unless one is an experienced player. Over time, exact methods may not be able to attract adequate assets.
Investors can lessen their chances of going through an ETF liquidation by conducting thorough research on the ETF and avoiding a probable closeout. There’s no need to panic if the ETF liquidates; simply investigate the next fund and make sure to understand what one is getting into.
FAQs
What happens to the assets in an ETF when it closes?
When an ETF closes, its assets undergo a liquidation process, where they are sold off in the market. The resulting proceeds from the asset sales are then distributed among the shareholders of the ETF.
This distribution is typically done on a pro-rata basis, ensuring that each investor receives their fair share of the remaining value.
One advantage for investors is that this process is usually tax-free, meaning they don’t have to worry about incurring additional tax liabilities when the ETF closes. It provides a relatively seamless exit strategy for investors who no longer wish to hold shares in a particular ETF.
Can investors experience financial losses when an ETF closes?
While it is possible for investors to face financial losses when an ETF closes, such occurrences are relatively rare. In the event of an ETF closure, investors may potentially experience losses if the liquidation value of the ETF’s assets is lower than the value of the shares they hold.
However, it’s important to note that ETF sponsors prioritize ensuring investors are adequately reimbursed for the full value of their shares. This reimbursement helps mitigate the risk of significant financial losses.
As a result, investors are typically provided with a safety net that helps protect their investment capital in the event of an ETF closure.
How can investors prevent investing in an ETF that might close?
To avoid investing in an ETF that might face closure, investors can adopt a diligent approach. They should conduct comprehensive research on the ETF they are considering.
This research should encompass various factors, such as analyzing the ETF’s underlying holdings, assessing its historical performance, and evaluating its management fees.
By delving into these aspects, investors can gain a better understanding of an ETF’s stability and its potential for long-term success. Furthermore, investors can look for ETFs with a larger asset base.
ETFs that have amassed a significant amount of assets are generally more financially stable and less likely to face closure.
