48 Zombie ETFs

September 02, 2010

You are right, Dave, that some small ETFs can be late bloomers, attracting significant assets after months or years of gathering dust.

But it’s pretty rare. For the most part, zombie funds are zombie funds, and we’d be better driving a silver stake through their hearts.

In case you missed it, Dave and I have been debating whether the ETF industry should shut down funds to “clean house.” I argued that earlier in a blog “Industry Should Close 200 More ETFs,” and Dave thought I was a cold-hearted, anti-innovation fool in his riposte titled “Low Asset ETFs Can Be Tradable.”

One of the things that Dave disliked about my original post is that I tarred all funds with less than $10 million in assets under management as candidates for closure. While I think that’s generally true, there’s not much nuance there, so it pays to dig a little deeper and come up with a more focused list of “dead funds walking.”

To do this, I started with the list of 206 funds with less than $10 million in assets. These funds are candidates for closure simply because they lose money for issuers. Most issuers are in the business of making money, so this is not an attractive proposition.

To narrow down the list, I then screened for funds that had less than 5,000 shares of trading on average over the past three months. These funds are truly unloved, with neither assets nor trading; they just sit in the corner and whimper. They also create problems for investors, who can be locked into the funds by wide spreads and uneven liquidity.

This reduced the worrisome list of ETFs to 173.

From here, I screened out all HOLDRS and ETNs. HOLDRS cannot be closed, and ETNs are so cheap for issuers to run that closing them is beside the point.

This reduced the number of ETFs on our watch list to 113.

From there, I screened out all ETFs that have been on the market for less than a year. You have to give funds a chance to attract critical mass.

That left 41 funds.

To Dave’s point, some of these funds are just waiting for their moment to shine. I can construct a world where the CurrencyShares Russian Ruble ETF sudden turns red hot. But the First Trust US IPO ETF (NYSEArca: FPX)? That fund has been on the market since April 2006, has only $9.98 million in assets and trades just 3,500 shares a day. I just don’t see the IPO idea “suddenly” catching on. And the Claymore/Ocean Tomo Growth ETF (NYSEArca: OTR), which has pulled in $6 million in assets in the last three years? The PowerShares FTSE Nasdaq Small Cap ETF (NasdaqGM: PQSC), which launched in April 2008, has just over $1 million in assets and trades just 700 shares a day?

Goner, goner, goner.

Not every fund on my list of 41 is doomed, but if I were a betting man, I’d guess that half these funds will close in the next 12 months.

And you know what? That wouldn’t be a bad thing, either.

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