Analysis: Closure of small ETFs won’t slow market

By Aaron Pressman

BOSTON (BestGrowthStock) – Managers have pulled the plug on 14 small exchange-traded funds over the past month, but the $800 billion U.S. market is still on track to post another year of net expansion.

The latest wave of closings is part of the typical “trial and error” process the ETF market relies on to uncover new hits, according to Roger Nusbaum, chief investment officer at Your Source Financial in Phoenix, Arizona.

“The funds to be closed are all ‘me too’ funds without the benefit of a brokerage firm making them commission-free,” Nusbaum said. “This will not be the last group of funds to close down.”

For example, the Claymore/Beacon Global Exchanges, Brokers & Asset Managers Index ETF (EXB.P: ) attracted less than $3 million as it competed against much larger rivals like the $83 million iShares Dow Jones U.S. Broker-Dealers Index Fund (IAI.P: ) and the almost $50 million KBW Capital Markets ETF (KCE.P: ). The Claymore fund closed on September 10.

The most recent announcement came last Friday when Old Mutual Global Index Trackers, a unit of South African insurer Old Mutual (OML.L: ), said it would close its five U.S.-listed ETFs.

BIG BOYS HEAD-TO-HEAD

Until 2008, the industry had never shuttered more than a handful of funds in a single year. But the financial crisis and the collapse of some major firms prompted managers to close 58 exchange-traded funds and notes in 2008 and 56 in 2009, according to the ETF-oriented website Indexuniverse.com.

Even with a total of 37 ETFs closed so far in 2010, more than 150 new ETFs have been launched. Dozens of new funds have been launched by large asset managers including BlackRock’s (BLK.N: ) iShares unit, Vanguard Group and State Street Corp (STT.N: ).

Vanguard opened seven new funds last week based on popular Russell stock indexes. BlackRock opened a New Zealand equity fund earlier this month, its 30th single-country ETF. And PIMCO, famous as the home of Bill Gross’ $248 billion Total Return Fund bond mutual fund, opened new ETFs investing in investment-grade corporate bonds and Build America Bonds.

Amidst the escalating competition, BlackRock, Vanguard and Charles Schwab started offering commission-free trading for certain customers. And several firms have also trimmed management fees on popular funds.

“The big boys are starting to go head-to-head competing on cost, which will make it even tougher for smaller firms to define a niche that will allow them to survive,” said Ron Rowland, chief investment officer at Capital Cities Asset Management in Austin, Texas.

Investors who own an ETF that is being closed should use a limit order to sell their shares before the last day of trading to avoid getting caught up in the liquidation process, Rowland recommended.

Rowland and others who track the ETF market predict more small funds will close. Of the nearly 1,000 funds and related exchange-traded notes listed in the United States, 213 have less than $10 million in assets, according to Indexuniverse.com.

Rowland maintains an ETF “death watch” which includes all funds that have been open at least six months and traded less than $100,000 worth of shares in the prior month.

With 153 funds on the list for September, there are plenty more candidates for closure.

(Reporting by Aaron Pressman, editing by Matthew Lewis)

Analysis: Closure of small ETFs won’t slow market