Tiny exchange traded funds present significant risks to investors. The problems associated with such funds may include overconcentration, high fees, illiquidity, lack of transparency, and wide trading spreads.
There are approximately 1,498 exchange traded funds operating today. 929 of them have less than $100 million in assets. They reportedly account for just 1.7% of the $1.2 trillion in assets held by exchange traded funds, but represent 62% of the total number of exchange traded funds.
In addition, many of them are unprofitable and end up shutting down. For example, last month Russell Investments announced it would shut down 25 of its 26 exchange traded funds that had been operating for less than 2 years and held about $300 million in assets (“Lots of ETFs, but So Many Are Tiny,” Wall Street Journal).
Similarly, FocusShares, a unit of the online brokerage company Scottrade Inc., reportedly closed 15 funds that had collectively attracted a little less than $100 million in assets in just over a year of business.
When an exchange traded fund shuts down, investors may be hit with taxes and redemption fees or have their money tied up during a wind-up period.
John Bogle, the founder of Vanguard and the creator of the first index mutual fund, said of tiny niche ETFs: “It’s insanity. This is a classic case of Wall Street trying to capitalize on the worst instincts of investors.” They are unsuitable for many investors and should be approached with caution, if at all.
Page Perry is an Atlanta-based law firm with over 170 years of collective experience maintaining integrity in the investment markets and protecting investor rights.