ETF shutdowns are all part of the game

If you’ve ever been at a kids’ soccer game when it had to be cancelled by lightning, you will have surely noticed the kids don’t like it, not one little bit. They’re out there having fun, and then some grownup shuts down the game. Winning or losing doesn’t matter, they just want to play.

Some ETF investors are likely feeling like those soccer kids after several ETFs this week were officially terminated. Horizons Exchange Traded Funds Inc. closed four BetaPro COMEX funds — Silver Inverse, Gold Inverse, Long Gold/Short Silver Spread, Long Silver/ Short Gold Spread — and the BetaPro U.S. 30-year Bond Bull Plus ETF. Its GMP Junior Oil and Gas Index ETF is set to close Aug. 10.

Investors, who will get paid the full net asset values at the time of closing, minus any applicable fees and expenses, may not like it, but closings are just part of the ETF game. Sometimes, funds are simply not economical. Occasionally, funds are launched to take advantage of a certain investor demand, but if that demand quickly fades away, then an ETF provider is left with a

product that is simply not selling.

Even the low fees typically associated with ETFs won’t help. A smaller fund will feel the impact of fees more than a larger fund, because administration fees and other expenses are divided over a smaller base. In addition, very small funds can be detrimental to investors because their bidask spreads tend to be high, and liquidity by default tend to be very low.

One interesting thing about ETF closures is that a shareholder vote isn’t generally required. We combed through the prospectuses of many ETF companies (not all, as there are far too many) and each one indicated management could terminate an ETF “at their discretion.”

In the mutual fund world, a unitholder vote is typically required before a fund can be closed. Mutual funds, however, are almost never closed, although National Bank this week did announce the termination of four NxT Funds. Instead, mutual funds are usually merged with other existing funds. Investors get a say on the merger and end up with units in the continuing fund, which gets to spread administration fees over a larger asset base, resulting in a lower MER.

Occasionally, ETFs will also

merge, but most don’t because many of them are so specialized in one particular investment area. Under investment regulations, to merge an ETF into another ETF, both need to have similar investment objectives. It is next to impossible to find a fund that is similar enough to, say, a gold/ silver spread ETF to satisfy regulators.

We have heard from some disgruntled ETF investors who are not happy when their funds close. Perhaps they have been averaging down on their holdings in order to earn greater profits when the sector or fund they are trading decides to move up again. We understand their frustration, but, having come from the mutual fund world, we know it’s sometimes just not economical to keep a fund running.

A mutual fund generally needs $25-million in assets or so to make it even remotely economic. Paying a fund manager, independent investment review committees, trustees, etc. all adds up, so mergers usually make sense when funds fall below the $25-million threshold. Of course, finding similar funds to merge is often easier since most mutual funds are not nearly as specialized as some ETFs.

ETFs, by design, have lower

fees, so the economic asset threshold is much lower. There are plenty of funds out there that have less than $10million in assets. But as the ETF industry continues to grow, closings will become a way of life.

If you feel you absolutely must go ultra short on the Mexico market, you may not have much time left to buy ProShares UltraShort MSCI Mexico Investable Market (SMK/NYARCA), which has just $1.9-million in assets. Or, if North American financials haven’t caused you enough pain, try iShares’ Far East Financials Sector Index Fund ETF (FEFN/NAS), that has $2.2-million in assets. Or maybe there is still some time to finally profit from global warming with Credit Suisse Group ELEMENTS CS Global Warming ETN

(GWO/NYARCA), an exchangetraded note linked to the Credit Suisse global warming index, that has $2.8-million in assets.

We’re kidding of course. These three almost never trade, haven’t been stellar performers, and their closings can’t be very far away.