by Will Ashworth | March 21, 2013 10:32 am
Exchange-traded fund closings have become routine.
So routine, in fact, there’s actually a monthly ETF Deathwatch[1] that keeps track of funds living on borrowed time. Just last month, Guggenheim Investments announced it was shuttering nine funds with assets totaling $144 million.
ETFs face intense pressure to gather assets immediately; as with a rookie stockbroker, instant results seem to be all that matter. In a world where big is beautiful, new funds from new companies hardly stand a chance. We investors need more players[2], not fewer.
There’s no question ETF marketers other than BlackRock (NYSE:BLK[3]), State Street (NYSE:STT[4]), Vanguard and PowerShares have their work cut out for them.
But what about the average investor intent on building a retirement portfolio based on the best products available, regardless of size? What’s he or she to do knowing that many potentially attractive investments are here today and gone tomorrow? Given the limited shelf life of some of these funds, conducting a search can be overwhelming.
Using the now defunct Guggenheim MSCI EAFE Equal Weight ETF (EWEF) as a case study, I’ll examine its history before, during and after its life as an exchange-traded fund. Looking for the clues that led to its demise, I’ll determine the key ingredients that separate the successful from the also-rans.
EWEF’s life began as the Rydex MSCI EAFE Equal Weight ETF on Dec. 3, 2010. Rydex was part of Topeka-based insurance company Security Benefit, acquired in August 2010 for $400 million by Guggenheim Partners.
A year later, Guggenheim Partners removed its Rydex/SGI investment management business from Security Benefit and combined that with Guggenheim’s investment management business, naming the merged entity Guggenheim Investments. In recognition of the new corporate name, EWEF was changed from Rydex to Guggenheim in February 2012. One year later, it’s in the trash bin.
The EWEF lasted 27 months and 12 days. Although it first showed up on the ETF Deathwatch in March 2012, it was on shaky ground from the start. All ETFs get six months lead time before they are eligible for the not-so-special list, which means EWEF’s first month of eligibility would have been July 2011. It didn’t show up in the second half of 2011, nor into the first two months of 2012. And then boom … 12 consecutive months facing the threat of liquidation.
When it first entered the list in March 2012, it had assets under management of $11.5 million with 46,000 in three-month average daily volume. In February, its last month on the list, it had $12 million in AUM and 118,000 in three-month average daily volume.
To get off the list, a fund must go three consecutive months with trading volume greater than 100,000. The EWEF did 97,000 in January, up from 83,000 in December. But while volume appeared to be rising, the lack of growth ($25 million is the estimated minimum to profitably run a fund) in AUM killed its chances of survival.
When Guggenheim announced the fund’s closure on Feb. 15, it let investors know that the last day of trading would be March 15 — exactly one month later. The announcement gave shareholders plenty of time to sell their shares.
Of course, there would be a brokerage commission for anyone wishing to do so. If you’re exiting a fund — especially one that’s about to close — remember to use use a limit order. And though I wouldn’t recommend it, another option would be to hold through liquidation, receiving your portion of the proceeds on March 22.
By holding through liquidation you generally avoid a transaction fee, but there are examples where funds winding down have charged fees — in some cases exorbitant ones. In other instances, fund companies have simply delisted ETF shares without bothering to liquidate assets, forcing you to sell over-the-counter. This last reason is why most people exit before delisting.
The easiest way to survive a messy liquidation is to avoid it in the first place. Proper research should provide you with ETF candidates whose assets under management are growing while also being sufficiently liquid to exit your investment should the need arise.
While the ETF Deathwatch uses $25 million as a bare minimum for AUM, I’d recommend looking for $100 million when selecting a fund; equally important is the idea that the $100 million is growing, not stagnating. As for liquidity, I’d err on the side of caution and make the cutoff point 1 million shares a day rather than 100,000 for the three-month average daily trading volume.
Using these stricter baselines doesn’t completely forestall a closure, but it certainly lowers the odds. If it does get to that point, you’re better off selling immediately and moving on to another investment.
As for ETF marketers, the best way to avoid closing funds is to stop creating so many harebrained schemes based on indices that have no hope for success. I truly hope Guggenheim remains committed to equal-weight ETFs despite these recent closures because, for my money, they make a lot more sense than cap-weighted funds.
As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.
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