College students sometimes amuse themselves by throwing JELL-O against the wall to see if it sticks. In the 1990s, the exchange-traded fund (ETF) industry adopted a similar marketing strategy for new funds. Fund companies threw handfuls of new ETFs at the public all at once − with the hope that they would stick.
The JELL-O method worked for many years, as most early launches captured enough assets to survive. Today, however, more new JELL-O is falling to the floor than sticking. This is due in part to oversaturation in the ETF industry.
ETF JELL-O throwing began in earnest during 1999 when iShares launched more than 30 funds during a two-month period. The ETFs covered a wide range of size and style equity indices that were not available prior to the iShares launch.
Demand for style ETFs was high, and first-to-market iShares picked up several hundred million in assets rather quickly. Fast asset growth always leads to an increase in competition. During the 2000s, dozens of new ETF companies have launched multiple competing funds to iShares using the JELL-O method.
Demand doesn’t always follow supply and the ETF market is no exception. As more companies throw more JELL-O at investors, most of those ETFs will fall to the ground. That appears to happening now. At 68 fund closures so far, 2012 is turning into a bad year for JELL-O fans.
Scottrade closed 15 FocusShare ETFs this month that tracked Morningstar indices. The press release cited a lack of assets. Last week, Russell Investments announced it was closing down 25 ETFs because they also failed to gather assets. Both companies launched their ETF JELL-O at investors during 2011. The fast fund closure indicates that demand for new product just isn’t there.
When a fund closes, the ETF stops trading on an exchange and cash is distributed to shareholders within two weeks. The closure process creates problems for investors and for the industry. Investors have to wait a week or so for their money and then have to find a comparable ETF, if one exists. Some taxable investors are forced to realize capital gains that they weren’t expecting. The ETF industry also suffers. Multiple closures makes gathering assets in new funds more difficult as investors take a wait and see attitude.
Today there are about 1,500 exchange-traded products in U.S. exchanges. Of these, 377 are on Ron Rowland’s ETF Deathwatch, and his list doesn’t include many of the 111 new funds that are less than 6 months old. These funds haven’t gathered enough assets to justify their existence. Odds are they won’t be around a couple of years from now. I recommend that long-term investors avoid them.
You would think ETF companies would stop throwing JELL-O and take a more targeted approach. That doesn’t seem to be happening. While Russell closed two dividend-seeking ETFs because they failed to gather assets in this oversaturated category, FlexShares announced they were jumping in with six new dividend ETFs. Will FlexShares’ JELL-O stick where Russell’s didn’t? We’ll have to wait and see.