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Must-know: Why do most sub-­scale ETFs face shutdown risk?

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Asset concentration and shutdown risk

Though ETF assets in the U.S. have been growing, the most successful funds account for a majority of the assets. Currently, 46% of ETFs in the U.S. are sub-scale (<$75 million in assets), and cumulatively, they account for less than 1% of assets, putting them at risk of shutdown.

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In theory, when an ETF delists and liquidates, investors should receive cash equivalent to the fair value of the securities held in the fund. In practice, however, most money managers would prefer to avoid this scenario. For example, a delisted ETF may not always liquidate immediately. There may also be downsides related to reputation and taxation. Having a simple way to identify shutdown risk can be important.

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There are several idiosyncratic factors that could cause an ETF to shut down, including an ETF sponsor exiting the market entirely. This makes it difficult to predict accurately which ETF will shut down. The net asset level for an ETF is the simplest indicator for monitoring potential shutdown. We judge ETF net assets less than $75 million to indicate high shutdown risk, between $75 million and $500 million to indicate moderate risk, and more than $500 million to indicate low risk. It’s important to note that this metric is conservative and a “blunt instrument,” since there are several ETPs that have low assets but may not be closed because they’re a piece in a broader fund family. However, we believe net assets is a good starting point to assess shutdown risk.

As of year end 2013, there were 1,536 ETPs listed in the U.S.. Of these, only the 1,377 listed for at least a year prior to this cutoff date (the “eligible universe”) have been included in this table, since recently launched ETPs need time to gather assets. Almost half the ETPs listed fall in the “high risk” of shutdown category.

For more ETF analysis, see 2 things you must know before investing in bond ETFs.

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