At BlackRock Even a 40% Gain Can’t Save ETFs From the Trash

BlackRock Inc. Ahead of Earnings

BlackRock Inc. offices in New York.

Photographer: Scott Eells/Bloomberg
  • Finance giant to close 10 money-making funds with low assets
  • Liquidations expected to rise as number of new ETFs skyrockets

Making money isn’t enough to survive in the fund industry anymore.

BlackRock Inc., the world’s largest asset manager, plans to shutter 10 exchange-traded funds this month, despite all posting gains this year. One soon-to-close fund, the iShares MSCI Emerging Markets Latin America ETF, is up 38 percent.

So why are these funds on the chopping block? Because in spite of their strong performance they’re just not that popular with investors. On average, the condemned ETFs -- which include portfolios focused on inflation-linked debt, high-yield bonds and emerging markets -- oversaw just $30 million of investors’ capital apiece; the Latin America fund managed $9 million.

Liquidation, once reputational suicide in the money management business, is fast becoming commonplace as a doubling in ETF assets under management over the past five years has encouraged fund companies to cull their failing products. So-called zombie ETFs -- funds that have attracted little trading activity or investment -- are increasingly destined for the trash bin by providers seeking to streamline their offerings.

Industrywide casualties this year include ETFs designed to tap demand for Chinese assets and currency hedging -- both strategies that garnered billions of dollars for some funds but not for others.

Making A Mark

“It’s good to have the weeding out,” said David Perlman, an ETF strategist in New York at UBS Wealth Management. “From a performance perspective an ETF can be a success, but if no one’s owns it, it’s not going to survive. Assets are a big part of it -- it’s definitely not the only factor, but you need to hit a certain threshold to continue your existence.”

Far from signaling industry hardship, increasing liquidations reflect the ETF industry’s ebullient growth. More than 1,700 ETFs are competing for capital in the U.S., up from roughly 900 just five years ago.

This growth, however, has made it increasingly hard for products to make their mark on the $2.4 trillion market. Of the 226 funds started in the last 12 months, only 21 have gained more than $100 million of assets, data compiled by Bloomberg show. Funds need approximately $75 million to $100 million to survive, UBS’s Perlman estimates.

BlackRock’s Thesis

Between 2013 and 2015, liquidations and delistings across the U.S. rose to 200, up almost 50 percent from the previous three years, data compiled by Bloomberg show. This year, fund managers have closed 33 funds, with a further 31 slated to get chopped this month, according to announcements from State Street Corp., ProShares and BlackRock.

“We regularly review our ETF line-up to ensure the funds are meeting the current and future needs of our clients,” BlackRock spokesman Paul Young said.

BlackRock has reviewed its ETF business at least once a year since 2014, closing funds in March and October of that year, and again last August. The latest batch traded for the last time on Aug. 23. To put that in perspective, the money manager has started 93 ETFs since 2013, more than double the number it has axed, data compiled by Bloomberg show.

Why Funds Flop

ETFs fail for as many reasons as they succeed. First, strategy is key -- if investors don’t buy the rationale for a fund that bets on high-yield debt using credit-default swaps or one that seeks income via put options, it’s doomed. Second, don’t be late, because stepping onto a crowded field dominated by major players is a deadly strategy. The fund company Direxion closed a leveraged euro-hedged ETF after less than a year when it failed to lure investors from the more than 40 other currency-proof funds already out there. And third, a fund’s methodology may become dated.

Invesco PowerShares Capital Management, for example, shut down its China A-Share Portfolio ETF in March after concluding that the market had evolved beyond its strategy. The product, which never topped $24 million in assets, offered investors exposure to China using index futures; but funds that use the government’s quota to directly buy stocks ultimately garnered more interest.

“We had a bit of an outdated technology,” said Dan Draper, head of Invesco PowerShares, during an interview at Bloomberg’s headquarters. “We try not to, but if we need to close, we will certainly do that.”

Costly Business

Running a standard index-tracking ETF costs about $250,000 every year, after startup expenses of at least $2 million, according to Sam Masucci, chief executive of ETF Managers Group, a company that helps aspiring fund providers get established for as little as $75,000. Those that are more niche products, requiring leverage or derivatives for example, require more capital to sustain them. Shuttering funds allows those resources to be re-allocated.

The process of closing an ETF is simple. The provider alerts the Securities and Exchange Commission that the fund is to close and contacts exchanges, broker-dealers, market makers and investors to communicate the date it will stop trading. The ETF will then be delisted and dissolved, with the remaining shareholders receiving their portion of the proceeds from the liquidation. One reason ETF managers may be loathe to close funds is the proceeds can be subject to capital gains taxes, making the investments less tax efficient, which is one of their key selling points.

With the global ETF universe set to grow to $15 trillion over the next decade according to exchange Bats Global Markets Inc., liquidations will become a natural part of the market fabric.

“We don’t want products that clients aren’t interested in trading,” said Sylvia Jablonski, head of capital markets and institutional strategy at Direxion. “We do everything we can to get the word out and let the investing public know that the product is there. But then, at the end of the day, it’s really up to the client.”

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