While the closure of exchange-traded funds might seem like a negative subject, investors have the potential to learn quite a bit from funds of this type that go under.
ETFs have proliferated over the last several years and have drawn substantial business away from mutual funds due to their lower fees, strong returns and wide range of investment objectives.
Investors can learn from fund closures
Investors can potentially derive great benefit from harnessing ETFs, but they of course need to keep in mind that not all of these funds make for great investments. Individuals who want to make money by trading these financial instruments could potentially derive significant benefits from taking a look at the ETFs that have closed and the reasons these funds failed.
A total of 337 of these investment schemes have failed thus far, exchange-traded-fund analyst Eric Balchunas notes in a recent Bloomberg opinion piece. It is also important to keep in mind that more than 40 percent of these funds were shut down over the last 18 months.
As of September 9, 53 of these ETFs were shuttered in 2013, Index Universe reported. This compares to last year, when a total of 95 of these funds were closed. In addition, data provided by Index Universe’s ETF Analytics unit revealed that of the 1,500 of these funds that are listed in the United States, roughly one-fifth are at risk of being shut down.
Importance of assets under management
It is important to note that of these investment schemes that have a high chance of going under, most have less than $15 million in assets under management, according to the news source. The importance of a fund’s AUM was recently noted by ETF analyst Spencer Bogart in a recent Index Universe blog piece.
The author stated that while the assets held by a fund are not the only important matter when determining where to invest, ETFs that have more than $50 million in AUM will likely be making generous enough profits to not be in danger of closing. Likewise, if a fund has hundreds of millions worth of these assets, it would probably be rather unreasonable for such a venture to be shut down.
Funds could shutter for many reasons
While this measure of the assets that a fund has under management may be important, there are many other reasons that a fund could close down, Balchunas wrote. He stated that ETFs have stopped operating due to regulatory changes that might seem completely spontaneous.
In addition, he noted that some funds were simply launched at the wrong time. For example, Balchunas observed that Global X Fishing Industry, an ETF, was introduced shortly after a series of unfortunate events struck Japan, which is one of the countries where many of the fund’s holdings resided.
This fund only managed to round up $1 million in assets from interested investors, and within six months of its launch, the ETF plunged by 25 percent, according to Balchunas. The author also noted that because of the sharp gains that Japanese equities have experienced over the last year, this particular fund could have surged 31 percent during that period.
Benefits of these closures
Bogart noted that if an investor picks out an ETF and the fund then closes, it can be very inconvenient. That person might have just devoted significant time to the process of reviewing different investments in order to pick out the one that they thought would be best-suited to their specific objectives. Going through these steps once again could certainly be time-consuming.
He noted that if one fund closes, there is always a more viable alternative out there. Also, the monies that an investor puts into an ETF are not at risk if the fund indeed closes. As a result, people who want to make money by trading these financial instruments need not worry about losing their principal should one of these investment vehicles shut down.
Also, the primary benefit of some of these funds shutting down is the ones that do survive will be stronger, Balchunas wrote. Due to the significant monetary resources that have been flowing into these ETFs, and the robust competition for investor dollars, it is inevitable that some of the funds will cease to exist.
Due diligence is key
Investors who want to make money by trading ETFs need to keep in mind that performing the needed due diligence is crucial. There are a wide range of factors they can potentially consider if they are thinking about putting money into a certain fund.
Bogart noted that there are tax liability considerations for different funds. Obviously enough, people who are considering them must weigh their investment objectives and their past performance. In addition, the author noted that the strength of the financial institution offering the ETF should be considered. In the event that the firm goes under, it could close all of its funds.
Individuals should compile a list of key factors and then check potential investments against this list when conducting their due diligence.
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