So you thought that Exchange Traded Funds or ETF's were risk free? Just because an index based ETF is tracking that underlying index, and that underlying index is not going to close down or go bankrupt, that does not mean that the ETF will not close down. The fact is the ETF's or Exchange Traded Funds, do close down or shut down and there is a risk in such ETF investments or Exchange Traded Funds investments.
Let's address the issues one by one:
1) My ETF tracks a major index, hence returns will always be similar to the performance of the index:
No - that is not always the case.
As covered with full details in the article Largest ETF List: Low Prices do matter for ETF, we discuss a case of 3rd and 4th largest ETF's which are tracking the same underlying index, yet the returns from both the ETF's are different.
So dont live under the false impression that ETF's tracking the same index will give similar returns. There are other factors as well (like fund charges and prices), which might affect the ETF returns
Exchange Traded Funds ETF Closure Shut Down
2) ETF or Exchange Traded Funds never close down:This is myth no. 2. let's look at some stats - The table below shows number of ETF's closed down in USA in the given years.
Year - No. of ETF's Closed
2010 - 49
2009 - 56
2008 - 58
As we can see, there are quite a significant no. of ETF's which are closing down each year. Although one can argue that the no. is declining each year (from 58 in 2008 to 49 in 2010), but the fact is that there are ETF closures. What if you ended up holding your major investments in one of these closed ETF's?
Another thing which can be argued is if around 50 ETF's are closing each year, there are 100's more which are coming up new. Correct, but here we are not worried about what new investment options are coming up. We need to worry about what happens if our invested ETF closes down.
What are the signals that ETF might close down or shut down?
Although there are no such signals which can be clearly mentioned, one can keep a close look at some of the numbers and recent market activities for a particular ETF.
- Is there a sudden decline in the asset under management amount for an ETF?
- Is there a sudden change in the trading volume of an ETF? Are investors redeeming the ETF units at a high pace?
- Is there a remarkable change in the performance of the ETF with respect to its underlying index i.e. high tracking error? like if the index is up by 2% today, your ETF is up only 1%? This typically happens when the fund company which sells ETF has problems.
- Is there another similar ETF which is following the same index and there is a big difference between the returns of the 2 ETF's?
All these pointers can be checked at regular intervals to see if the ETF is showing any signs of problems and is prone to ETF closure.
What to do if my invested ETF has closed down or shut down?
Unfortunately, there is no standard procedure which is followed by the ETF company for closing down the ETF and redeem the units for the ETF investors. What typically happens is the advantages of ETF's become the disadvantages if it is declared to be closed down. Like one of the advantages of ETF is that it trades like a share in open stock market. However, if a closure declaration or closure news comes in, the same open market trading can cause huge selling pressure and prices might fall dramtically. If you happen to sell in that panic mode, you might incure losses.
Other option is to wait till the final redemption date or liquidation date actually comes close, i.e. the last trading date or redemption date of the ETF, and then take what you get. However, again, you dont have any control over what you will get as the actual value will depend upon the market prices, redemption process etc.
So, just dont live under the false impression that ETF's are fool proof investments. Keep a close eye on what's going on with your invested ETF as listed above. ETF's do have risks and they do shut down causing Exchange Trade Funds Closure.
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