As we have discussed in this space before you just never know when a particular idea is going to (if ever) take hold in the blogosphere.   Indeed an old investing aphorism (original source unknown) comes to mind:

Being early is the same as being wrong.

This is especially for true for value investors who may spot value in a stock and see it either continue to decline or move sideways, before eventually moving up.  In either case the investor has incurred opportunity costs in the meantime.  Unlike for investors, opportunity costs for bloggers are measured in time and pixels, not dollars.

Eleanor Laise at has an article discussing the issues facing investors in ETFs that have garnered few assets and trade infrequently.  Because of a lack of seed funding ETF sponsors are launching funds with fewer assets.  If the ETFs are unable to attract much in the way of assets they are much more expensive for investors to trade.

The ranks of less-liquid ETFs are expanding as money available to seed new ETFs dries up but fund companies continue to roll out new products. Though many funds don’t attract much cash, they are relatively cheap to launch so fund companies will continue to throw products at the wall to see what sticks, ETF analysts said. There are more than 500 ETFs in registration, waiting to be launched.

The ETF industry has yet to learn the lesson from these, as Matt Hougan describes them, “zombie underclass” of ETFs.  This shouldn’t come as a surprise to anyone who has been following the industry.  We early (three years) on the question of too-small ETFs, but we like to think we were not wrong.  As we wrote back then:

An orphaned ETF will be one in which assets are small and not growing. This illiquidity will make them difficult to buy and sell making them even less attractive. Larger ETFs that have moved far beyond this phase are highly liquid and attractive to both traders and investors. If you are a long term investor issues of commissions and bid-ask spreads are less crucial than for shorter term traders, but they are something to keep in mind.

Michael Johnston at ETF Database notes that the ETF industry of late has moved beyond the issuance of plain vanilla, broad-based, plain vanilla ETFs.  (One exception might be in the fixed income ETF arena.)  The growth in ETFs seems to be coming from niche products and a pent-up wave of actively managed ETFs.   So expect more fund launches and more ETFs that eventually get orphaned.

The ETF industry is also facing the twin challenge of what happens when a fund gets too big for its own good.  Many commodity ETFs are getting roiled as they reach limits in terms of their ability to own futures.  The problem is bad enough where the prime advantage of ETFs, their open-ended nature, may get rolled back. Daniel Harrison at writes:

Nobody knows how long the ongoing debate will rage in Washington, D.C. But the longer federal authorities take to decide whether to place limits on commodity investments, the more likely it becomes that a greater number of ETPs will be forced to act like close-end funds.

This issue will eventually get resolved, but not necessarily in favor of the commodity ETF sponsors.   Things are only going to get tougher for the ETF industry.  On the one hand it has to worry about launching funds that may (or may not) garner enough assets to be viable.  On the other hand they are facing issues of size as the push into non-standard assets and strategies inevitably run into capacity constraints.  In short, the easy money has been made in the ETF industry.  New entrants will find a tougher path to profitability.

That doesn’t mean more funds won’t get launched.  Again at ETF Database an industry executive notes that there are still a number of firms itching to enter the ETF industry.  This is due in part to many firms reliant on open-end mutual funds playing catch-up.  Even though the issue of too small to trade ETFs is out there it is unlikely to deter the launch of more ETFs.

The issue of zombie/orphan ETFs investors and the complications surrounding commodity ETPs are not going away any time soon.  That being said, the creation of ETFs has been a boon to traders and investors alike, but the ETF industry is exactly that a business.  A business that profits from putting additional assets under management.

As new ETFs launched we will all be told the many benefits of the new fund.  However we all need to be skeptical consumers of this information on new ETFs, especially when it comes to actively managed ETFs.  In short, the key for investors, as always, is to know what you own.


Check out the ETF Deathwatch at Invest With An Edge to see what funds are potential candidates for closing.

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