Everybody knows starting a restaurant is a risky business. But most investors may not realize that cooking up a new exchange-traded fund recipe has a surprisingly high failure rate as well. And that can cause some unpleasant surprises for investors who’ve bought shares in funds that shut down. When funds liquidate, they distribute the cash value of their holdings to investors, potentially triggering unplanned-for taxable capital gains or losses.
Fortunately, investors who stick with large, broadly diversified ETFs generally don’t have to worry about closures, says Daniel Sotiroff, a senior analyst for investment research firm Morningstar. Likewise, limiting investments in risky ETFs to tax-deferred accounts will eliminate closure-related tax headaches.
But anyone who has taken, or is considering taking, fliers on smaller funds, especially ones with risky, niche or region-specific strategies, should limit their stakes and take a few steps to protect themselves, advisers say.
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ETF closures: More common than you think
For starters, recognize how frequent ETF closures are. Fund sponsors expect fees, charged as a percentage of assets, to (at least eventually) cover their operating expenses and lead to profits. Consequently, companies tend to shut funds that fail to attract enough assets; consistently underperform and thus are likely to drive investors away; or face challenges such as investing in areas affected by geopolitical conflicts.
In fact, about one-third of all ETFs ever started have shut down, Morningstar calculates. Over the past 10 years, that has added up to 1,550 shuttered funds. In 2024 alone, despite inflows of more than $1 trillion into ETFs overall, 189 closed (an above-average number).
Moreover, many of the closed funds were sponsored by well-established companies, offered attractive-sounding strategies or garnered plenty of popular attention. Fund giant BlackRock liquidated at least 15 funds in 2024, for example, including its four-year-old Future Tech ETF. Despite profiting from holdings such as Nvidia, that fund never attracted significant investments — it charged comparatively high annual fees of 0.88%, and its performance lagged other tech funds. Large fund sponsors such as Global X and Pacer also liquidated China-focused funds in 2024 as that country faced political and financial challenges. Another notable 2024 closure: the Inverse Cramer ETF, which gained media attention (but not many investors or profits) by short selling stocks touted by CNBC personality Jim Cramer.
The rate of ETF closures is likely to accelerate from the current pace, especially if the stock market experiences a prolonged downturn, Sotiroff believes. A record 711 ETFs were launched in 2024, many specializing in risky strategies involving cryptocurrencies or using leverage, which involves borrowing against assets to goose returns. “When times are good, people like to gamble,” says Sotiroff. Fund sponsors “are throwing spaghetti on the wall to see what sticks.”
ETFs to avoid
To avoid the ETF equivalent of spaghetti on the floor, Sotiroff and other ETF researchers suggest investors steer clear of funds with less than $100 million in assets that also display any of these red flags:
Risky strategies. Fund sponsors are increasingly offering strategies that stretch beyond plain vanilla. Think “triple leveraged” funds that use debt to triple the returns (or losses) of a basket of volatile stocks, for example, or “inverse” funds that profit when the stocks they focus on fall. Those kinds of funds tend to attract fickle, short-term traders rather than long-term investors. That helps explain why leveraged and inverse funds, which accounted for only 11% of all ETF launches, made up 16% of all ETF closures, says Aniket Ullal, head of ETF Research & Analytics for research firm CFRA.
Lagging returns. Companies tend to shutter funds that consistently underperform their competitors. Of 168 now-closed funds with Morningstar performance data for 2023, the average return was just 7%, in a year in which the S&P 500 index returned 26.3%. More than one-fourth of the shuttered funds lost money that year.
Missing profits. Investors naturally prefer to pay lower fees. But fund companies need to cover costs such as legal expenses, management and marketing. Any fund with a combination of fees and assets that fails to generate at least $100,000 a year is probably not making much money, Ullal says. According to Morningstar data, as of December 31, more than 900 of the approximately 4,000 ETFs currently traded in the U.S. were producing less than $100,000 a year for their sponsors.
If you see any of these red flags in funds that you own, it pays to monitor them, says Steven Novack, a CPA and certified financial planner for Altfest Personal Wealth Management in New York City. It’s important to check on each questionable fund separately; because the notification procedure is governed by a patchwork of laws and rules from the Securities and Exchange Commission, states and exchanges, one fund’s closure process may not match another’s. Generally speaking, if a fund’s board of directors votes to liquidate, the fund must at least issue a press release and add a supplement (sometimes called a “sticker”) to its prospectus laying out the schedule and process by which it plans to stop accepting new investments, sell its holdings and distribute the cash to shareholders.
Investors who don’t monitor such press releases can easily miss a closure notification. Major fund sponsors such as BlackRock typically don’t send closure notices directly to investors. And several major brokerages contacted by Kiplinger said that although they update fund documents on their sites with closure notices, they don’t automatically message investors about them. As a result, many investors may be surprised when they see cash replace shares in their portfolio.
What to do if your ETF closes
In the event you find out that a fund you’re holding is closing, Novack generally recommends that you sell your shares as soon as possible. Fund companies typically halt all trading in a closing ETF a few days before the liquidation date, and trading volume tends to decline as the end approaches. Thinly traded ETFs may see unusually wide spreads between the prices sellers are asking for their shares and the prices buyers are willing to pay, which means you might get a little less than you’d like.
To avoid selling at a discount, you can consider holding on until the bitter end, in which case you’ll get the fund’s full net asset value (the value of its underlying holdings, less liabilities) on the fund’s final day. It also pays to wait if those extra days or weeks put your holding period over the one-year mark, qualifying you for lower long-term capital gains tax rates.
Note: This item first appeared in Kiplinger Personal Finance Magazine, a monthly, trustworthy source of advice and guidance. Subscribe to help you make more money and keep more of the money you make here.