Size Matters: Why Are So Many Exchange-Traded Funds Closing?

The exchange-traded fund industry, better known as ETFs, is undergoing a consolidation much like that in banking and other sectors. ETFs trade like stocks and seek to match or beat established indexes like the S&P 500. However, smaller players in the industry are often at risk of liquidation as they can’t compete with bigger rivals nor attract enough assets to remain viable.

A few weeks ago Invesco Ltd. (IVZ) said it planned to shut down 42 ETFs comprising $1.13 billion in total assets by Feb. 14.

Upon closure Invesco will be left with 220 remaining ETFs with nearly $220 billion in assets under management.

The ETFs to be liquidated range in size from $2.4 million to $78.8 million. Surprisingly, eight of the targeted ETFs have assets in excess of $50 million – usually ETFs above this figure are considered to be viable enough to survive.

More than half of these ETFs were originally operated by firms Invesco had acquired in recent years, including OppenheimerFunds and Guggenheim’s ETF business. Many of the acquired ETFs overlapped with Invesco’s existing product line.

ETF firms have been closing underperforming ETFs in recent years. On the whole, asset managers closed at least 109 ETFs in 2019, 79 in 2018 and 127 in 2017. Many of these closed ETFs were small in asset size and focused on niche investments.

The industry now encompasses about 2,400 ETFs and $4.3 trillion in assets.

For investors, ETF closures mean they have to liquidate their holdings in the fund and eventually get hit with a capital gains tax.

The Wall Street Journal reported that many ETFs are shrinking in asset size, rendering them doomed to closure, while the larger players in the industry keep accumulating more assets. Industry titans BlackRock Inc., Vanguard Group and State Street Corp. together control 81% of all ETF assets. These huge firms can manage large, passive, low-cost products.

Between 2014 and mid-2019, about 24% of ETFs disappeared while 30% of those remaining shrank in size.

“You need to have deep pockets to keep these funds going,” said Scott Sacknoff.

Sacknoff’s fund, the socially responsible SerenityShares Impact ETF, closed in March 2019. At its zenith it had $6 million in assets.

“Everyone who looked at our materials and methodology loved it,” Sacknoff said. “But financial advisers said, ‘We can’t invest in you.’ At the end of the day it came down to our market cap.”

Indeed, the larger ETFs not only dominate the market but also dominate asset growth.

Michael Cornacchioli, a vice president of investment strategy at wealth management firm Clarfeld Citizens Private Wealth, said he doesn’t even bother with ETFs with less than $1 billion in assets.

Elisabeth Kashner, director of ETF research at FactSet Insight, said if a fund cannot attract $50 million to $100 million in its first three years of operation, it is likely to close.

A report in Barron’s suggested ETF closures are actually good for the industry.

Dave Nadig, founder of ETF.com, estimated that for every closed fund, there are one-and-a-half new launches – down from a ratio of two launches for every closure four years ago.

“This is very healthy,” he said. “The last thing the investment world needs is a bunch of zombie ETFs with no assets and no volume. That leads to potentially bad experiences for investors. I would much rather see funds close.”

Todd Rosenbluth, head of ETF and mutual fund research at CFRA, agreed.

“At the industry level, closures are healthy as they remove products from the shelf that were not in demand and allow asset managers to focus … on products that are appealing to a large audience,” he said. “It is common for a firm to launch and close products in the same year.”