Exchange-Traded Duds: ETF Ideas That Are Striking Out

by on September 2, 2011 | ETFs Mentioned:

Impressive growth has been a defining characteristic of the ETF industry over the last several years, as both the number of products and aggregate asset totals have skyrocketed. While a big portion of the expansion is attributable to “plain vanilla” ETFs offering exposure to well known stock and bond indexes, the introduction of funds targeting new asset classes and investment strategies has made a major contribution as well.

Many of the new ETF ideas that have popped up in recent years have been tremendous successes. The growth of commodity ETPs, leveraged products, small cap international funds, and volatility ETFs and ETNs are just a few examples of innovative ideas that have attracted significant assets in a relatively short period of time.

While the ETF industry has an impressive track record of success in new areas, the history is not without a few failures as well. Several ETF issuers have shut their doors over the last decade after failing to gain traction with investors. Some seemed like game-changing innovations, while others were seemingly destined for failure from the start. From the ill-fated HealthShares to Northern Trust’s short-lived first shot at the ETF industry to the MacroShares Oil Up and Oil Down products, more than a hundred exchange-traded products have terminated operations as a result of tepid investor interest [see ETF Hall of Shame].

A look at the current landscape of the ETF industry reveals that a number of different strategies have struggled to gain traction with investors:

1. Faith-Based Investing Strikes Out

A number of exchange-traded products launched in recent years have sought to appeal to investors looking to manage their portfolios in accordance with the guidelines set forth by their religious denomination. These funds are defined more by what they exclude than by what they include, generally avoiding companies engaged in industries such as gambling or liquor that may run afoul of tenets of the relevant religion. The result is a portfolio that looks generally similar to broad-based equity indexes, but with a few critical omissions.

The market for these products should be massive–an assumption that is no doubt shared by the firms that brought these products to market. But investors demand has been non-existent. From the Sharia compliant ETF introduced by Javelin (JVS) to the FaithShares products constructed to comply with various Christian denominations, there has been almost no investor interest. JVS shut down last year, and FaithShares just recently pulled the plug on its lineup of five funds that had aggregate assets of less than $20 million.

2. Target Retirement Date ETFs Struggle

Some of the more peculiar ETFs are a suite of products that are designed to function as one stop shops for portfolio management, delivering a diversified, balanced portfolio in a single ticker. Many of these products, generally structured as ETFs-of-ETFs, are an extreme in low maintenance, managing the shift towards lower risk securities as retirement date approaches and risk tolerance presumably declines.

Currently, there are 15 ETFs in the Target Retirement Date ETFdb Category. As the name suggests, these funds are designed for investors looking to retire in or around a certain year, offering a portfolio consisting of stocks and bonds for those a certain number of years away from retirement. These funds, which have target dates ranging from 2010 (TZD) to 2050 (TZY), presumably appeal to investors looking to keep their portfolios simple. But despite some lengthy track records–some have been around since 2007–assets remain on the low side. None of these funds has more than about $35 million in assets, and most have struggled to get to the $10 million threshold [see all the Target Date Retirement funds here].

It is perhaps relatively easy to understand the lack of interest in this corner of the market. These funds are built in the “one size fits all” mold, but the portfolio construction process often requires specialization and customization. Time to retirement should certainly be considered when splitting exposure between stocks and bonds, but there are other factors that merit consideration as well. Willingness and ability to take on risk, overall wealth, and magnitude of current income can have a big impact on the optimal allocation for investors, and the simplicity of the target retirement date ETFs limits their ability to consider these metrics.

3. FocusShares: Slow Out Of The Gates

The FocusShares suite of ETFs launched earlier this year have been slow to gain traction with investors, a somewhat surprising development considering that many ETF investors strive to maximize cost efficiency. FocusShares, which previously offered a lineup of hyper-targeted ETFs that struggled to attract assets, returned in 2011 as a division of Scottrade. And instead of offering products that concentrate on sub-sectors, the resurrected FocusShares ETFs are quite broad in nature; included in the lineup of 15 ETFs are sector-specific ETFs and funds that focus on U.S. stocks of various sizes.

The appeal of the FocusShares ETFs lies in the rock bottom expense ratios. The Focus Morningstar U.S. Market Index ETF (FMU) and Large Cap Index ETF (FLG) charge just 0.05%, making them the cheapest ETFs out there. Each of the sector-specific ETFs is the cheapest in its ETFdb Category, undercutting the ultra-popular Sector SPDRs by a single basis point in many cases. Moreover, FocusShares ETFs are eligible for commission free trading in Scottrade accounts, a feature that should further increase the appeal of these funds to cost-conscious investors [see the list of 25 Cheapest ETFs].

Yet, for some reason, FocusShares have been slow to catch on. None of the funds have cracked the $10 million level, and most have less than $5 million in AUM. Considering the tendency of ETF investors to gravitate towards low cost options–as evidenced by the rise in popularity of VWO and IAU–it’s somewhat surprising that FocusShares haven’t become more visible to ETF investors [see ETF Investors Embracing Cheapest Options (Sometimes)].

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Disclosure: No positions at time of writing.