Why You Shouldn’t Worry About ETF Closures

by on September 4, 2012 | Updated July 8, 2014

The ETF space has been a hot spot for growth in the investment landscape over 2002 to 2014. Exchange-traded products have come a long way since 1995 when merely two funds in total were in existence. As of 2014, investors can choose from an extensive lineup of nearly 1,600 offerings, showcasing how self-directed investors and professional money managers have bolstered demand for these financial instruments. However, the ever-expanding product roster has also lead to waves of ETF closures, causing some to worry that the growth of the industry will be overwhelmed by a string of liquidations [see also Free Report: How To Pick The Right ETF Every Time].

In short, that’s just nonsense. As with any financial instrument, with innovation also comes complexity, and ETFs are no exception. Similar to how mutual funds saw a meteoric rise in popularity in the 1980s and ’90s followed by waves of contraction, the ETF industry too must mature. Simply put, ETF closures are a natural part of the industry’s life cycle. Given the announcement in 2012 of closures to come from Direxion, Russell and FocusShares, many have been quick to point fingers and exaggerate how these liquidations are a sign of weakness for the industry as a whole. Once again, that’s just nonsense.

Relax, It’s Healthy

When some people bring up the topic of ETF closures it seems as if they choose to entirely ignore the fact that the mutual fund industry has endured virtually the same process of maturing. What better way to illustrate this point than to look at the numbers. As such, below we have compiled two tables from the 2012 ICI Investment Company Fact Book, which compares the total number of ETFs and mutual funds operating, opening up and shutting down each year. The last column in the tables below, Closure %, shows the number of liquidations relative to the total number of products operating that year for both ETFs and mutual funds.

ETFs Total At Year-End Created Liquidated Closure %
2008 728 149 50 6.9%
2009 797 120 49  6.1%
2010 923 177 51 5.5%
2011 1,134 226 15  1.3%
Mutual Funds Total At Year-End Created Liquidated Closure %
2008 8,880 706 333 3.8%
2009 8,612 500 503  5.8%
2010 8,540 552 237  2.8%
2011 8,684 580 194  2.2%

On average, the Closure % for ETFs has been higher over the past few years, although it’s crucial to remember that this industry is still very much in its infancy compared to the mutual fund industry, which is years past its peak from both a growth and popularity perspective. Keep in mind that the ETF space is still attracting assets left and right while mutual funds are slowly falling out of favor among self-directed and professional money managers alike. In 2011, according to IndexUniverse, mutual funds gathered $58 billion in new money while the ETF universe saw inflows of $119 billion [see also 101 ETF Lessons Every Financial Advisor Should Learn].

Garrett Stevens, CEO of Exchange Traded Concepts, recently commented on this phenomenon, stating “There is a natural selection process in the industry; people bring products to market that don’t take off for some reason.  Maybe they are too advanced, too confusing or the regulators don’t like them, but it’s a part of the industry and not everything works” [see also 10 Reasons ETFs Are Better Than Mutual Funds].

Simply put, ETF closures should be expected instead of looked upon as warning signs of slowing growth for the industry as a whole. In fact, the exact opposite is true. An increasing number of new funds opening up each year coupled with a somewhat steady contraction rate simply demonstrates that the ETF space is maturing in a healthy way. Garrett went onto comment, “While it is unfortunate for those people involved, it’s a part of the maturing of the industry, and I don’t think it’s anything negative, just natural.” The bottom line is that although ETF closures are nothing to celebrate about, they most certainly aren’t foretelling of slowing growth or lack of demand; instead, investors should view liquidations as a natural, healthy part of the industry’s life cycle.

Follow me on Twitter @SBojinov

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Disclosure: No positions at time of writing.