A Guide to ETF Liquidation (2024)

Since the first ETF began trading in the U.S. in 1993, exchange-traded funds (ETFs) have become one of the most popular investment vehicles available to individual investors.

By the end of August 2023, there were 9,904 global ETFs. But 244 ETFs closed in 2023.

Read on to learn what happens when an ETF shuts down.

Key Takeaways

  • Introduced in the U.S. in 1993, ETFs have become one of the most popular investment choices for investors.
  • ETFs may close due to lack of investor interest or poor returns.
  • For investors, the easiest way to exit an ETF investment is to sell it on the open market.
  • Liquidation of ETFs is strictly regulated; when an ETF closes, any remaining shareholders will receive a payout based on what they had invested in the ETF.
  • Receiving an ETF payout can be a taxable event.

Reasons for ETF Liquidation

The top reasons for closing an ETF are a lack of investor interest and a limited amount of assets.

For example, investors may avoid an ETF because it is too narrowly-focused, too complex, too costly, or has a poor return on investment. They may prefer a broader market-tracking ETF with solid year-to-year returns from a well-known investment company.

And when ETFs with dwindling assets no longer are profitable, the investment company may decide to close out the fund. Generally speaking, ETFs tend to have low profit margins and therefore need sizeable amounts of assets under management (AUM) to make money.

Although ETFs are generally considered lower risk than individual securities, they are not immune to problems such as tracking errors and the chance that certain indexes may slow other market segments or active managers.

$54 million

The average amount of assets under management held by ETFs that failed in 2023. The average age of these ETFs was 5.4 years.

The Liquidation Process

ETFs that close down must follow a strict and orderly liquidation procedure. The liquidation of an ETF is similar to that of an investment company, except that the fund also notifies the exchange on which it trades that trading will cease.

Notification

Shareholders typically receive notification of the liquidation between a week and a month before it occurs, depending on the circumstances. The board of directors, or trustees of the ETF, will confirm that each share is individually redeemable upon liquidation since they are not redeemable while the ETF is still operating. They are redeemable in creation units.

Redeeming Shares

Investors who want out of their investment upon notice of an ETF's impending liquidation can sell their shares on the open market. A market maker buys the shares and they are redeemed.

Those shareholders who don't close their position in the ETF while it is still traded will receive their money, most likely in the form of a check. The amount of a liquidation distribution is based on the number of shares an investor held and the net asset value (NAV) of the ETF.

Tax Consequences

The liquidation can create a tax event, if an ETF is held in a taxable account. So investors may owe capital gains taxes on any profits received when their shares are redeemed.

4 Ways To Identify an ETF on the Way Out

It is possible to reduce your chances of owning an ETF that may close and then having to search for another place to stash your cash.

The following four tips can help investors determine whether an ETF is likely to face some trouble:

1. Be alert to ETFs that track narrow market segments. These products are considered risky and therefore require careful evaluation.

2. Examine an ETF's trading volume. Volume is a good indicator of liquidity and investor interest. If the volume is high and the price is rising, the ETF most likely is liquid and people want to own it. That can be a good sign of ETF vitality.

3. Look at the AUM to determine how much money fund managers have to work with to achieve returns that please investors. High and growing levels of AUM can point to a fund's success and its ability to attract greater numbers of investors.

4. Review an ETF's prospectus, to understand what type of investment you are holding. Typically available upon request, the prospectus will provide information about fees and expenses, investment objectives, investment strategies, risks, performance, pricing, and other information.

Are ETFs Good for Beginners?

Yes, ETFs are a popular investment choice for inexperienced beginning investors because they do not require a great deal of time or effort to manage. For example, instead of having to research and select stocks yourself (or pay someone to do so), the ETF that you buy with a single, convenient purchase will already be invested in a broad range of stocks in which you're interested. And most ETFs typically have low expense ratios.

How Long Do You Have To Hold an ETF?

There is no required minimum holding period for an ETF. But you should be careful about trading an ETF too frequently. If you buy an ETF within 30 days of selling the same or a substantially similar security, you may run the risk of breaking the wash sale rule, which would prevent you from claiming a loss on your taxes. Holding an ETF for longer than a year may get you a more favorable capital gains tax rate when you sell your investment.

How Do You Choose a Good ETF?

When choosing an ETF, investors typically look at the underlying index, risk profile, and portfolio composition to determine if the fund aligns with their investment goals. It is also important to look at the fund's management costs. The lower the expense ratio, the better the return for the investor.

The Bottom Line

In the U.S., ETFs have been around since the early 1990s. They provide investors with an array of attractive features—instant diversification, low costs, the flexibility of intraday trading, and more. Yet, even while new ETFs may be launched, others may shut down.

If you find yourself holding an ETF that is being closed, there's no reason to panic. You'll get your money back and can search for another ETF in which to invest.

A Guide to ETF Liquidation (2024)

FAQs

What happens if an ETF is liquidated? ›

Liquidation of ETFs is strictly regulated; when an ETF closes, any remaining shareholders will receive a payout based on what they had invested in the ETF. Receiving an ETF payout can be a taxable event.

Has an ETF ever gone to zero? ›

Leveraged ETF prices tend to decay over time, and triple leverage will tend to decay at a faster rate than 2x leverage. As a result, they can tend toward zero.

Are ETP easy to sell? ›

ETPs are designed to resemble an underlying index or return of an asset, with convenient trading and access. They are just as easy to buy and sell as the shares; at any moment, the market is available.

How do you calculate liquidity of an ETF? ›

This liquidity is visible through metrics such as trading volume, market depth, and the bid-ask spread. High trading volumes and narrow bid-ask spreads frequently signify good liquidity, making it easier and cost-effective for investors to trade.

What are the risks of ETF liquidation? ›

Often, the ETF will realize capital gains during the liquidation process, which it will pay out to the shareholders of record and that could mean an unnecessary tax burden. There will also be transaction costs, uneven tracking, and various other grievances.

Can an ETF lose all its value? ›

"Leveraged and inverse funds generally aren't meant to be held for longer than a day, and some types of leveraged and inverse ETFs tend to lose the majority of their value over time," Emily says.

Why is ETF not a good investment? ›

Buying high and selling low

At any given time, the spread on an ETF may be high, and the market price of shares may not correspond to the intraday value of the underlying securities. Those are not good times to transact business.

Why I don't invest in ETFs? ›

ETFs are most often linked to a benchmarking index, meaning that they are often not designed to outperform that index. Investors looking for this type of outperformance (which also, of course, carries added risks) should perhaps look to other opportunities.

Is my money safe in an ETF? ›

Key Takeaways. ETFs can be safe investments if used correctly, offering diversification and flexibility. Indexed ETFs, tracking specific indexes like the S&P 500, are generally safe and tend to gain value over time. Leveraged ETFs can be used to amplify returns, but they can be riskier due to increased volatility.

When should I sell my ETF? ›

Every quarter or every 6 months when you receive your dividend payment, just log into your broker account and sell off a small number of shares in your ETFs to access extra cash. That is the right time to sell your ETFs.

What is the difference between an ETF and an ETP? ›

Exchange-traded funds (ETFs) are a specific type of ETP that tracks an underlying index and can be bought and sold on an exchange throughout the trading day. ETPs also include other exchange-traded instruments, such as exchange-traded notes (ETNs) and exchange-traded commodities (ETCs).

Can you sell a worthless stock? ›

Sell Worthless Stock if Your Broker Holds the Shares

And you sure don't want to pay a brokerage commission to get rid of your worthless shares. Many brokers have a plan to let their good customers sell them worthless stock for $1 or 1c for the lot. If you are a good customer, and stock is with the broker, ask.

What are the most liquid ETFs? ›

TLT is one of the most popular and liquid ETFs in the bond space, with an AUM of $51.1 billion and a Zacks ETF Rank #4 (Sell). iShares iBoxx $ High Yield Corporate Bond ETF is the largest and most liquid fund in the high-yield bond space, with AUM of $19 billion and an expense ratio of 0.49%.

Which liquid ETF is best? ›

Comparison Of Returns By Liquid ETFs And Liquid Funds
SCHEMES1 Wk Return (%)6 Mth Return (%)
DSP NIFTY 1D Rate Liquid ETF0.12.52
ICICI Prudential S&P BSE Liquid Rate ETF0.112.72
Nippon India ETF Nifty 1D Rate Liquid BeES0.12.52
Liquid Fund Average0.132.96
Jan 12, 2023

What is a good volume for an ETF? ›

Volume and market impact

The higher the volume, the better. For example, if XYZ trades, on average, 10 million shares per day, it will be easier to trade than something that trades 100 shares per day.

What happens if an ETF gets delisted? ›

When an ETF delists without liquidating its portfolio, investors who fail to sell their shares before the last trading date will be forced to trade over the counter—a significantly less liquid, more cumbersome and generally more expensive process than trading on an exchange.

Is there a fee to liquidate ETFs? ›

ETFs don't often have large fees that are associated with some mutual funds. But because ETFs are traded like stocks, you may pay a commission to buy and sell them, although there are commission-free ETFs in the market.

What happens to an ETF when a stock is delisted? ›

When an ETF is delisted, it means it can no longer be bought or sold. A fund company can delist an ETF for various reasons, such as a lack of investor interest and assets. When the fund closes, it is liquidated shortly after a specified date and investors receive their share of the proceeds from the liquidation.

Can an ETF ever go negative? ›

In other words, you could potentially be liable for more than you invested because you bought the position on leverage. But can a leveraged ETF go negative? No. If you own a leveraged ETF you can't lose more than your initial investment amount.

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