ETF LIQUIDATION: OVERVIEW
Since its inception in 1989, numerous exchange-traded funds have emerged. However, not all funds outlasted. Numerous reasons can be attributed to the liquidation of ETFs, but the most common ones include limited assets and lack of interest among investors. Speaking of investors, some of them may not invest in ETFs because of low liquidity, limited concentration, or too much complexities.
Insufficient assets can make an ETF and its company unprofitable. These funds tend to have minimal profits. Hence, they need more assets to generate money. Yes, ETFs can offset losses in a portfolio, making it a great tool for diversification. Still, such funds are susceptible to certain problems when investing in different instruments such as potential tracking errors.
Granted the ETF is shutting down, companies need to strictly follow the liquidation process. The procedure is almost the same with that of an investment firm, except the fund needs to inform the bourse where it is trading that it will close its operations.
Investors need to be informed as well. The notification should reach them at least a week or a month before its cessation. The fund’s board of directors or trustees will agree each stake is redeemable after liquidating it. For shareholders who want to get out of the ETF before its closure, they should sell their stakes. They can only redeem their portion if the firm purchases those shares. The remaining investors will receive their share for whatever was left in the ETF, normally in the form of check.
However, this event can incur taxes in case the ETFs are held in a taxable account. It can pressure a shareholder to pay capital gains taxes on any profits they obtained.
The Investment Company Fact Book said over $1.4 trillion of new ETF shares have been released over the last decade. Still, it does not guarantee they will prevail longer than expected in the market. Here’s what you have to do to determine if a fund is on the edge of exiting the industry:
Move away from ETFs which trail narrow market segments as much as possible.
Look into the fund’s trading volume.
Review the underlying assets and gauge its success rate.
Evaluate the ETF’s prospectus and its holdings.