Low net asset ETF — Issues?

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delamer
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Low net asset ETF — Issues?

Post by delamer » Wed May 23, 2018 7:02 pm

I purchased an ETF early last year to fill in a hole in my asset allocation in my taxable portfolio.

This ETF has net assets of less than $3 million.

Based on comments on some other threads, I am concerned that the low value of the ETF is a problem in-and-of-itself.

I bought this as a long-term investment, of course.

Any insight would be appreciated.

alex_686
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Re: Low net asset ETF — Issues?

Post by alex_686 » Wed May 23, 2018 8:11 pm

So, a low net asset value ETF is not viable. At this size the fund family has to be subsidizing the fund. You can figure this out by reading the prospectus and seeing what fees are being waived. Either the ETF is going to grow into a viable fund or the fund family will pull the plug. Track the asset under management for the past few years - are they going up or down. If the fund family pulls the plug expect a hefty capital gains dividend.

delamer
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Re: Low net asset ETF — Issues?

Post by delamer » Wed May 23, 2018 8:23 pm

alex_686 wrote:
Wed May 23, 2018 8:11 pm
So, a low net asset value ETF is not viable. At this size the fund family has to be subsidizing the fund. You can figure this out by reading the prospectus and seeing what fees are being waived. Either the ETF is going to grow into a viable fund or the fund family will pull the plug. Track the asset under management for the past few years - are they going up or down. If the fund family pulls the plug expect a hefty capital gains dividend.

Thanks.

Can you expand on the “pull the plug” issue? What options does the fund company have if it discontinues the fund? Do the shareholders have any options?

drk
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Re: Low net asset ETF — Issues?

Post by drk » Wed May 23, 2018 8:40 pm

delamer wrote:
Wed May 23, 2018 8:23 pm
Can you expand on the “pull the plug” issue? What options does the fund company have if it discontinues the fund? Do the shareholders have any options?
Pulling the plug means closing and liquidating the fund. As a shareholder, you should receive a return of capital equal to your share of the NAV at liquidation.

delamer
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Re: Low net asset ETF — Issues?

Post by delamer » Wed May 23, 2018 8:46 pm

drk wrote:
Wed May 23, 2018 8:40 pm
delamer wrote:
Wed May 23, 2018 8:23 pm
Can you expand on the “pull the plug” issue? What options does the fund company have if it discontinues the fund? Do the shareholders have any options?
Pulling the plug means closing and liquidating the fund. As a shareholder, you should receive a return of capital equal to your share of the NAV at liquidation.

I had the idea that sometimes when a fund is closed that it is merged into another fund. In that case, I thought there would be no tax consequences for shareholders.

Am I off base?

alex_686
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Re: Low net asset ETF — Issues?

Post by alex_686 » Wed May 23, 2018 8:53 pm

delamer wrote:
Wed May 23, 2018 8:23 pm
Can you expand on the “pull the plug” issue? What options does the fund company have if it discontinues the fund? Do the shareholders have any options?
3 options

Liquidation - sell everything and return the cash

Merge - shares are converted into a bigger fund.

Repurpose - instead of tracking silver IIt now tracks Hong Kong real estate. It is often cheaper for a fund family to. Repurpose a fund into something new rather that fill out new paperwork to launch a new fund.

Resonbilie fund families give lots of notice on what is going to happen. Of course during times of stress who knows? Lots of ETFs closed overnight during the 2008 crisis.

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Re: Low net asset ETF — Issues?

Post by drk » Wed May 23, 2018 8:55 pm

delamer wrote:
Wed May 23, 2018 8:46 pm
I had the idea that sometimes when a fund is closed that it is merged into another fund. In that case, I thought there would be no tax consequences for shareholders.

Am I off base?
Honestly, I don't know, but that sounds worse than just getting my money back. This is why I won't touch ETFs with under $1 billion in assets.

delamer
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Re: Low net asset ETF — Issues?

Post by delamer » Wed May 23, 2018 9:04 pm

alex_686 wrote:
Wed May 23, 2018 8:53 pm
delamer wrote:
Wed May 23, 2018 8:23 pm
Can you expand on the “pull the plug” issue? What options does the fund company have if it discontinues the fund? Do the shareholders have any options?
3 options

Liquidation - sell everything and return the cash

Merge - shares are converted into a bigger fund.

Repurpose - instead of tracking silver IIt now tracks Hong Kong real estate. It is often cheaper for a fund family to. Repurpose a fund into something new rather that fill out new paperwork to launch a new fund.

Resonbilie fund families give lots of notice on what is going to happen. Of course during times of stress who knows? Lots of ETFs closed overnight during the 2008 crisis.

So the latter two would have no tax consequences for the shareholders? As in, they wouldn’t be forced to sell shares?

alex_686
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Re: Low net asset ETF — Issues?

Post by alex_686 » Thu May 24, 2018 8:36 am

delamer wrote:
Wed May 23, 2018 9:04 pm
So the latter two would have no tax consequences for the shareholders? As in, they wouldn’t be forced to sell shares?
Maybe.

In the last 2 the fund will still sell all of the assets. If they have a unrealized capital gain then it will be realized and you will see that at the year end when dividends are paid. Or they could pay out the capital gains dividend right before the conversion.

In theory the board of the fund has a fiduciary duty towards their stockholders - i.e. you. So they should try to minimize the tax impact on you.

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jhfenton
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Re: Low net asset ETF — Issues?

Post by jhfenton » Thu May 24, 2018 10:06 am

I generally wouldn't touch a non-Vanguard ETF at less than $100 MM in assets--preferably a few hundred million--and with steady asset growth. That's usually sufficient to ensure a fund's survival. In a taxable account, I would have even higher standards.

I've bought two ETFs at lower assets:

1. I bought EMGF (iShares Edge MSCI Multifactor Emerging Markets) last fall when it was just under $100 MM in assets.

I made an exception because it had just started to fairly steadily accumulate assets after iShares had cut the ER from 60 bp to 45 bp. It was clear at that point that the fund had crossed a threshold. I had to pick an ETF in my HSA at TD Ameritrade, so I decided EMGF was good enough for a buy-and-hold position in a tax-free account. The ETF is now at $259 MM in assets.

2. I bought VFVA (Vanguard U.S. Value Factor ETF) this spring when it had just over $7.5 MM in assets. Vanguard launched it with $7.5 MM and with that inventory of shares it took it a couple months to grow at all, but it is now at $23.8 MM.

Why was I willing to buy it so soon? Vanguard has never liquidated an ETF. Spreads were consistently a reasonable 8 bp ($0.06 on $75+/share). I was buying it in tax-advantaged accounts.

The next lowest ETF I own is Vanguard's S&P 600 Small Cap Value ETF (VIOV). It has only $339 MM in assets and has been around for 8 years. It's not going anywhere, but it's also not growing very much at this point because Vanguard hides its existence. But I own it in taxable because it is more tax-efficient than Vanguard's much larger VBR.
alex_686 wrote:
Thu May 24, 2018 8:36 am
delamer wrote:
Wed May 23, 2018 9:04 pm
So the latter two would have no tax consequences for the shareholders? As in, they wouldn’t be forced to sell shares?
Maybe.

In the last 2 the fund will still sell all of the assets. If they have a unrealized capital gain then it will be realized and you will see that at the year end when dividends are paid. Or they could pay out the capital gains dividend right before the conversion.

In theory the board of the fund has a fiduciary duty towards their stockholders - i.e. you. So they should try to minimize the tax impact on you.
At this point, I think the standard practice for merging a small fund into another would be to arrange an artificial flow of new assets sufficient to replace all of the appreciated assets in the fund through new creation units. Then the old assets would be off-loaded through an equal deconstruction of creation units. Funds do it all the time around index reconstitutions. There's still a cost involved to the fund, but it may be far smaller to shareholders than realizing capital gains.

delamer
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Re: Low net asset ETF — Issues?

Post by delamer » Thu May 24, 2018 10:16 am

Thanks again.

The ETF is only a couple years old, but it seems to have plateaued in terms of assets.

If I sell now I will have to pay tax on some capital gains, but there are worse things than making a bit of money. And I get to control when I take the gain. Plus I can move forward with my long-run reallocation plans.

It may be affected by the upcoming changes in the S&P500, in terms of the new major Communications sector. That is another reason that I am leaning toward taking action now.

livesoft
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Re: Low net asset ETF — Issues?

Post by livesoft » Thu May 24, 2018 10:19 am

I personally would not have bought the ETF in the first place whatever it is.

I'd like to explore the psychology of you buying these shares in the first place. First question: Is there another ETF in the same space by another sponsor that has lots of assets and volume?
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delamer
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Re: Low net asset ETF — Issues?

Post by delamer » Thu May 24, 2018 10:57 am

livesoft wrote:
Thu May 24, 2018 10:19 am
I personally would not have bought the ETF in the first place whatever it is.

I'd like to explore the psychology of you buying these shares in the first place. First question: Is there another ETF in the same space by another sponsor that has lots of assets and volume?

Bring on the therapy! :wink:

No, I did not have another option. When doing my research, this was the only ETF/mutual fund that met my needs at the time.

The sponsor is a well-known company. I was unaware of the issues with low value ETFs until I happened to see some comments in another Bogleheads thread.

I really do learn something every day that I am here.

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Re: Low net asset ETF — Issues?

Post by livesoft » Thu May 24, 2018 11:12 am

OK, second question, what needs did you have that only one low asset value ETF would meet them? With your 4K+ posts, I am sure you know that many people on this forum believe that needs can be met with just 3 funds.
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delamer
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Re: Low net asset ETF — Issues?

Post by delamer » Thu May 24, 2018 11:38 am

livesoft wrote:
Thu May 24, 2018 11:12 am
OK, second question, what needs did you have that only one low asset value ETF would meet them? With your 4K+ posts, I am sure you know that many people on this forum believe that needs can be met with just 3 funds.
I inherited a bunch of different assets from a credit shelter trust (that was managed by a bank trust department). That means that there was not a step-up in the cost basis for the assets. So I was trying to rationalize the portfolio without paying a lot of capital gains taxes; we were already in the AMT zone as a family, pre-inheritance. (In addition to the federal tax, my state has a high tax rate.)

The EFT balanced out the portfolio of individual stocks concentrated in a couple sectors.

The goal of the question was not to get portfolio advice, but to understand the issues with low value ETFs.

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Re: Low net asset ETF — Issues?

Post by jhfenton » Thu May 24, 2018 11:45 am

delamer wrote:
Thu May 24, 2018 11:38 am
The goal of the question was not to get portfolio advice, but to understand the issues with low value ETFs.
I think we've mostly covered the risk of closure. But in addition, you may have issue with low liquidity and high trading costs, both bid/ask spreads and substantial premiums or discounts to net asset value. Regardless of the risk of closure, you may not want to invest in a fund in which your purchase is a substantial fraction of the ETF's average daily volume. There are some small ETFs that don't even trade every day.

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Re: Low net asset ETF — Issues?

Post by livesoft » Thu May 24, 2018 11:50 am

My main issue is that I do not want to own any ETF where my total ownership will be more than about 5% of the average daily volume. So that might mean no more than 5,000 shares of something like DGS. One can then calculate that 5,000 * $52 = $260K.

A further calculation might be that $260K is 5% of a $5.2 million portfolio. There is probably not much reason to have a mere 5% in a single position in a portfolio which in turn means that if one is eventually going to grow their portfolio above $5 million, then DGS might not be a part of it. So if one wants DGS in a lower value portfolio, then they should not hold it in taxable account because they may want to unload all the shares when it becomes too small a portion of the overall portfolio.

OK, that may be too much "analysis" of the future, but there it is.
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delamer
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Re: Low net asset ETF — Issues?

Post by delamer » Thu May 24, 2018 1:21 pm

Thanks again for all the insight.

As I said earlier, I learn something every day on the forum.

This was definitely a case of not knowing what I didn’t know,

ecotone87
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Re: Low net asset ETF — Issues?

Post by ecotone87 » Thu May 24, 2018 9:58 pm

alex_686 wrote:
Wed May 23, 2018 8:11 pm
So, a low net asset value ETF is not viable. At this size the fund family has to be subsidizing the fund. You can figure this out by reading the prospectus and seeing what fees are being waived. Either the ETF is going to grow into a viable fund or the fund family will pull the plug. Track the asset under management for the past few years - are they going up or down. If the fund family pulls the plug expect a hefty capital gains dividend.
Thank you for the thoughts on how to use ETFs effectively. How do we track the AUM over time to see if increasing or decreasing for an ETF? I can see the current AUM on morningstar/etf.com/site for the etf. But have not found a graph showing the change over time.

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Re: Low net asset ETF — Issues?

Post by AlohaJoe » Thu May 24, 2018 10:39 pm

jhfenton wrote:
Thu May 24, 2018 10:06 am
I generally wouldn't touch a non-Vanguard ETF at less than $100 MM in assets--preferably a few hundred million--and with steady asset growth. That's usually sufficient to ensure a fund's survival.
This is a perfectly good rule of thumb but when I look over the ETF Deathwatch and lists of ETF closures, I came away feeling that concerns over ETF closure are a bit overstated on Bogleheads. ETFs that are closed generally come in two flavors:
  • They come from a provider that isn't a top-tier provider
  • They are very niche (at least by Boglehead standards) strategies
For the first: here are the companies that have closed ETFs this year.
  • IQ
  • Direxion
  • Janus
  • LocalShares
  • WisdomTree
Everything except WisdomTree is a "huh? who are they?" ETF provider. And WisdomTree's closure are a clear demonstration of #2. These are the funds that WisdomTree closed
  • WisdomTree Japan Hedged Capital Gds ETF (DXJC)
  • WisdomTree Japan Hedged Health Care ETF (DXJH)
  • WisdomTree Japan Hedged Real Estate ETF (DXJR)
  • WisdomTree United Kingdom Hedged Eq ETF (DXPS)
  • WisdomTree Global ex-US Hedged Div ETF (DXUS)
  • WisdomTree Strong Dlr Emerg Mkts Eq ETF (EMSD)
  • WisdomTree Global ex-US Hdgd Rel Est ETF (HDRW)
  • WisdomTree US Export & Multinational ETF (WEXP)
  • WisdomTree US Domestic Economy ETF (WUSA)
None of those are things that a Boglehead would consider investing it. (The ex-US real estate sounds okay on the surface but in reality it was tracking a WisdomTree proprietary index that weights by cash dividends paid, which I think would have scared off most Bogleheads.)

When I look back into 2017, I see the same two patterns repeated. The funds that actually close are either from places like BullMark, Global X, USCF, O'Shares, or Tierra XP. Or they were chasing very niche strategies like Bloomberg Natural Gas ETN, Developed EuroPacific Currency Hedged Low Volatility Portfolio, AMT-Free 12-17 Year Intermediate Municipal Index ETF, Solar Energy ETF.

And when you look at the AUM of closed funds, they usually are under $10 million. Very few funds -- from any provider -- shut down after passing $10 million. I didn't look that closely but I also get the impression that funds that shutdown tend to do so pretty quickly. That said, we don't exactly have a long track record with ETFs yet. Will we see funds hang around for 10 or 15 years, slowly lose assets, and then get shuttered after 20 years because they are down to $20 million (from a peak of $80 million)? Maybe?

I mean....don't take the above as license to start investing in just anything. But I think the risk of ETFs being shuttered is different & lower than the risk of a traditional actively managed mutual funds being shuttered.

alex_686
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Re: Low net asset ETF — Issues?

Post by alex_686 » Fri May 25, 2018 8:30 am

ecotone87 wrote:
Thu May 24, 2018 9:58 pm
Thank you for the thoughts on how to use ETFs effectively. How do we track the AUM over time to see if increasing or decreasing for an ETF? I can see the current AUM on morningstar/etf.com/site for the etf. But have not found a graph showing the change over time.
ETFs tend to have tickers that let you track AUM tick by tick. Pull the ETFs factsheet. However, this data tends to be restricted to commercial database providers like Bloomberg.

The other choice is to pull the quarterly reports.

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Re: Low net asset ETF — Issues?

Post by jhfenton » Fri May 25, 2018 10:42 am

AlohaJoe wrote:
Thu May 24, 2018 10:39 pm
I mean....don't take the above as license to start investing in just anything. But I think the risk of ETFs being shuttered is different & lower than the risk of a traditional actively managed mutual funds being shuttered.
I agree with your basic point. We probably do exaggerate closure risk.

On the flip side, I think about these iShares closures in 2016:

iShares Enhanced U.S. Large-Cap ETF (IELG | B-82), $71.2 million
iShares Enhanced International Large-Cap ETF (IEIL | C-74), $63.5 million
iShares Enhanced International Small-Cap ETF (IEIS | C-76), $18.3 million
iShares Enhanced U.S. Small-Cap ETF (IESM | C-78), $25.6 million
iShares MSCI Emerging Markets Latin America ETF (EEML | C-97), $8.6 million
iShares MSCI Emerging Markets Horizon ETF (EMHZ | D-53), $2.8 million
iShares International Inflation-Linked Bond ETF (ITIP | C), $25.5 million
iShares Global Inflation-Linked Bond ETF (GTIP | C), $14.7 million
iShares Baa - Ba Rated Corporate Bond ETF (QLTB | C-37), $36.3 million
iShares B - Ca Rated Corporate Bond ETF (QLTC | C-74), $11.2 million

They closed an entire family of "Enhanced" (i.e. active) ETFs with $178.6 million in assets across 4 funds. They closed international and global inflation-linked bond ETFs, which sound like reasonable, non-niche ETFs. The Baa-Ba bond fund also could have been interesting. According to ETF.com, it had over $100 million in assets at one point, "eliminating closure risk" in their words.

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Re: Low net asset ETF — Issues?

Post by jhfenton » Fri May 25, 2018 10:44 am

ecotone87 wrote:
Thu May 24, 2018 9:58 pm
Thank you for the thoughts on how to use ETFs effectively. How do we track the AUM over time to see if increasing or decreasing for an ETF? I can see the current AUM on morningstar/etf.com/site for the etf. But have not found a graph showing the change over time.
ETF.com has a fund flows tool. You put in tickers and dates, and it'll show flows.

delamer
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Re: Low net asset ETF — Issues?

Post by delamer » Fri May 25, 2018 9:03 pm

I ended up selling my shares in the ETF that inspired (for lack of a better word) this thread.

The price that I received was 0.6% below the NAV. I don’t have a feel for how that compares to the usual differences for larger ETF, but I am OK with it.

As I noted earlier, this ETF likely will be affected by the upcoming changes in the S&P500 sectors so I am glad to be done with that uncertainty too.

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