Large numbers of exotic and niche exchange traded products (both funds and notes) have either folded or are on a “death watch.” One such fund, according to John Waggoner of USA Today, has not traded since January (“Some exchange traded funds in ER”).
One major difference between an exchange traded product (ETP) and a traditional mutual fund is that the market price of an ETP only rarely reflects the value of the underlying holdings. Because exchange traded products trade intra-day, the share price of an ETP is often out of whack with the value of the underlying assets ? i.e., trades at a premium or a discount to the value of its underlying holdings ? most often a discount. The discount or premium spread can be significant.
Many unfortunate investors were not invested when funds were increasing in price, but instead bought at the top and rode them all the way down. After the ride down, exchange traded products often become illiquid as investors lose faith.
The industry has continued to pump out new exchange traded products. Since there have long been too many ETPs that tracks a broad index like the S&P 500 stock index, marketing entrepreneurs have created ever narrower and more exotic products with lots of sizzle but little if any benefit to investors.
The smaller-dollar exchange traded funds that tend to trade only sporadically tend to wind up on a death watch list. According to Lipper, there are 431 exchange traded products with less than $100 million in assets. To be eligible for inclusion on AllStarInvestor.com’s Deathwatch, a fund must have less than $5 million under management or an average daily trading volume of less than 100,000.
When an exchange traded product folds and is liquidated, the fund ? and ultimately the investors ? pays the cost of winding up. Recently, shareholders paid $750,000 or $0.87 per share to liquidate two MacroShares exchange traded funds, according to the article.
Other risks and problems associated with tiny exchange traded products may include overconcentration, high fees, illiquidity, and lack of transparency.
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.