ETF liquidation guide

Since its first launch in 1989, exchange-traded funds (ETFs) have become one of the most popular investment vehicles. The number of global ETFs in 2020 will reach 7,600+However, more than 180 ETFs will be closed in 2020. So what happens when the ETF is closed, and why?

Reasons for ETF liquidation

The main reasons for closing or liquidating ETFs include lack of investor interest and limited number of assets. Investors may not choose an ETF because it is too narrow, too complicated, or has poor return on investment. When an ETF with reduced assets is no longer profitable, the company may decide to close the fund; in general, ETFs tend to have lower profit margins and therefore require multiple assets to make money. Sometimes, it may not be worth keeping it open.

Although ETFs are generally considered to be less risky than individual securities, they are not immune to some typical problems, such as tracking errors and certain indexes that may slow down other market segments or active managers.

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Liquidation procedure

Closed ETFs must follow strict and orderly liquidation procedures. The clearing of ETFs is similar to that of investment companies. The difference is that the fund also informs its trading exchange that the transaction will stop.

Depending on the specific circumstances, shareholders usually receive a liquidation notice within one week to one month before the liquidation occurs. The board of directors or trustee of the ETF will approve that each share can be redeemed separately at the time of liquidation, because they are not redeemable while the ETF is still in operation; they can be redeemed as creative units.

Investors who want to “exit” the fund after the liquidation notice sell their shares; the market maker will buy the shares, and the shares will be redeemed. The remaining shareholders will receive their money, most likely in the form of checks, regardless of how much they hold in the ETF. The amount allocated for liquidation is based on the net asset value (NAV) of the ETF.

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However, if the funds are stored in a taxable account, the liquidation may trigger a tax event. This may force investors to pay capital gains tax on any profits that should have been avoided.

4 ways to identify ETFs on the way out

It can reduce the chance of holding ETFs that may be closed and having to find another place to store cash. The following four tips can help investors judge whether ETFs may face some troubles:

1. Carefully choose ETF products that track narrow market segments; these products are considered risky and therefore require more evaluation.

2. Check the trading volume of ETF. Trading volume is a good indicator of liquidity and investor interest. If the volume is large, the product is usually more fluid.

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3. Look at the assets under management to determine the amount of funds under management and measure the success of the fund.

4. Check the ETF’s prospectus to understand the type of investment you hold. Usually available on request, the prospectus will provide information such as fees and expenses, investment objectives, investment strategies, risks, performance, pricing and other information.

Bottom line

ETFs started in 1989 and provide investors with multiple options; they trade like stocks but hold a large number of securities. However, although new products are constantly being introduced, this does not mean that they will always exist. Investors can reduce the chance of ETF liquidation by ensuring that the ETF is thoroughly researched and reducing the chance of possible liquidation. Even if the ETF is liquidated, there is nothing to panic: just research the next fund you are interested in and make sure you know what you are investing in.

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