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Bloated array of ETFs results in liquidations

Exchange-traded funds have proven to be very popular with do-it-yourself investors and financial advisers since their introduction in 1993. But their popularity has led to the market being swamped with them, and as a result, some investors have seen their funds liquidated.

ETFs present a cornucopia of investment choices in low-cost trading vehicles that trade like a stock. But, similar to mutual funds, each ETF represents a variety of companies, thereby mitigating some of the risk associated with single-stock investments. As investors have scooped them up in their portfolios, issuers have introduced more and more ETFs to the market.

Morningstar estimates that 131 new ETFs have been issued to date in 2008. On the flip side of that, 21 ETFs have been liquidated this year because investors haven't pumped enough money into them to keep them afloat. Eleven of the flops were issued by Claymore Securities and 10 of those ETFs were just introduced in 2007. Ameristock/Ryan is liquidating five Treasury ETFs that also were issued in 2007. Morningstar says an additional 21 proposed ETFs were removed from the registration process in 2008 before they had a chance to be issued.

"It doesn't surprise me that some ETFs are being liquidated," says Kurt Rossi, Certified Financial Planner at Independent Wealth Management in Wall, N.J. "I looked at many of them, not just the gimmicky ones, but ones like midcap value. I'm sure there are at least 25 midcap value ETFs. Why would we need another one? If it's just an index and it's truly passively managed, then the only reason someone would invest in it is because of cost or because someone recommended it to them."

Index mimics
ETFs offer investors slices of the market by mimicking benchmark indexes such as the S&P 500, S&P MidCap 400, Nasdaq-100 and the like, along with a host of major sector and industry indexes covering real estate, health care, foreign countries, energy, finance and so on.

As hot, new investment areas rise to prominence, you can be sure an ETF will spring to life. For instance, you can now invest in a host of companies involved in wind energy through the First Trust ISE Global Wind Energy Index Fund (FAN) or PowerShares Global Wind Energy Portfolio (PWND). FAN and PWND may do well because there are so many people who want an easy way to invest in that sector without having to pick one or two companies that they probably know very little about. But what happens if wind energy gets blown off course by some other energy alternative?

Paul Justice, CFA, an ETF strategist at Morningstar, says to be careful about investing in an ETF that has less than $10 million in net assets.

Next: "If it drops to $5 million, it has a good chance of going away ..."
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