While year-to-date ETF flows are nearly 40% above their previous annual record and have surpassed the best year of inflows ever for mutual funds, the financial media seems strangely obsessed with ETF closures. Some recent headlines:
> Say hello to FAIL, my new ETF – Financial Planning
> More ETFs getting put on deathwatch – Investment News
Sure, ETFs receive plenty of positive attention too – the aforementioned record growth, low fees, new product launches, tax efficiency, etc. But the preoccupation with ETF closures is noteworthy because mutual funds fail to receive similar coverage. Consider that there is actually a website actively tracking ETF closures, under the heading “ETF Deathwatch” (ooooh – deathwatch!). This site is frequently referenced by the financial media. I’m still searching for the mutual fund deathwatch website. Now, it’s entirely possible a mutual fund deathwatch site doesn’t exist because everyone is already well aware mutual funds are in a heap of trouble. I would suggest the entire mutual fund industry is on deathwatch. Nevertheless, the fixation on ETF closures seems odd.
So why do I care? My concern is simply that many investors are still learning about ETFs. Bombarding them with headlines about ETF closures paints the impression that ETFs are somehow riskier than mutual funds in this regard. It gives the average investor a perception they may wake up one morning and, suddenly, their ETF and hard-earned money has vanished into thin air. For perspective, consider the following:
Look closely at these two charts. Note that in 2016 there were 602 mutual funds that were either closed or merged into an existing fund, compared to 128 ETF closures. In 2015, it was 467 mutual funds and 101 ETFs. As a percentage of total funds, recent closures have been nearly identical between mutual funds and ETFs – though, if you look back over the past 15 years, 58% (!!!) of U.S. stock mutual funds have disappeared. It strikes me as odd that I haven’t seen that headline anywhere.
If I had to pinpoint a reason for the excessive coverage on ETF closures, I think it comes back to ETF innovation. As I recently discussed, there are ETFs covering everything from rare earth metals and video games to robotics and cybersecurity. Some have expressed concern that there are too many ETFs and too many niche or gimmicky ETFs (though, again, I would point out that while there are 2,000+ ETFs, there are 8,000+ mutual funds and triple that figure with all the different mutual fund share classes). The proliferation of ETFs has been dubbed the “spaghetti cannon”, with ETF providers just firing launches at the wall and seeing what sticks (once again, take a look at the number of mutual fund launches in the chart above). The only thing I can think of is the financial media likes to point to ETF closures as rationale to help justify their claims of too many ETFs (not to be redundant here, but again, you could say the same thing about mutual funds).
I have another take on ETF closures. This is what innovation looks like. Remember MySpace? That was pretty innovative, but I don’t know anyone who uses MySpace anymore. Napster? Pretty darn innovative. Products launch and products fail or morph into something different all the time. The wonderful thing about creative innovation/destruction is good products stand the test of time and bad products don’t. MySpace spawns Facebook. Napster spawns Spotify. Innovation is crucial to society. Otherwise, we would all be living in caves and riding donkeys to work. The question I would ask is, “Do you want the investment industry to stop innovating? Is that a good thing for investors?” Remember, it wasn’t too long ago the average investor paid $100 per stock trade and 5%+ loads on index mutual funds were common (sadly, these still exist). I believe ETF closures are a sign of a healthy innovation and I would say the same for mutual fund closures. Money will always flow to where it is treated best. If investment firms cease to innovate, we are saying we can never do any better than what we have right now. This is as good as it gets. I disagree with that.
To be fair, there is no question some investment firms launch ETFs seeking to take advantage of fads and capitalize on short-term investor interest. In that regard, headlines on ETF closures do provide a service, reminding investors to be wary of investment products based on shaky investment foundations, that are poorly constructed, or too expensive. But this isn’t an ETF-only issue. There’s a cornucopia of mutual funds, hedge funds, non-traded REITs, annuities, etc. that suffer the same problems. Keep that in mind when you see ETFs singled out in the headlines.
One last note: even if your ETF does happen to close, the sun will still rise the next morning. While inconvenient and with the possibility of tax implications, your money doesn’t simply disappear. I would encourage investors to read this straightforward guide to managing and avoiding ETF closures from ETF.com. I prefer ETF education, not ETF scare tactics.