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What happens if an ETF folds?

By Sheyna Steiner ·
Wednesday, February 9, 2011
Posted: 11 am ET

Investors love exchange-traded funds, and that love just keeps growing. ETF inflows totaled $10.3 billion for the month of January, according to National Stock Exchange, a provider of exchange services.

Not only do assets continue to pour into ETFs but the investments themselves have multiplied like rabbits. At the end of January 2011, National Stock Exchange listed 987 ETFs. In January 2010, there were 857. Exchange-traded notes are not included in that number.

With so many new investments, there are bound to be some losers. The proliferation of ETFs means portfolio liquidations are becoming more common, Jessica Toonkel reported for on Feb. 8.

Over the past 3 years, 150 ETFs have folded, according to the story, "How to spot a doomed ETF."

Though there is no way to divine which ETFs won't make the cut in the long run, there may be a couple of red flags.

"… Funds headed for trouble tend to have a similar profile. An ETF that has been around for about 28 months and has less than $10 million in assets should raise a red flag for advisers, Mr. Rowland said. He gives new ETFs a six-month grace period to gain assets before they become eligible for his ETF deathwatch," Toonkel wrote.

About three to four weeks ahead of the closing, investors are notified that the ETF will stop trading. Shareholders can sell their holdings up to the date of the closing.

Selling before liquidation may be the right thing to do; it can take six to 10 days for investors to get their money after liquidation, according to the story.  

A Bankrate story from 2008, "Bloated array of ETFs results in liquidations," offered one caveat about selling shares prior to liquidation: "you may have to deal with a pretty wide bid/ask spread and decide whether you want to take what's offered," Laura Bruce wrote.

If no one wants to buy what you're selling, you may have less to lose by waiting for the fund to be dismantled. But that's not without risks either.

Back in August, a story on, "Your ETF is closing. Now what?" detailed one pitfall of sticking with your ETF to the bitter end when the securities underlying the fund are sold.

From the story:

"You will get the value of the securities from when they were sold, though, not when the ETF stopped trading. This means that if you decide to hold the ETF until this point, you’re running the risk that the underlying securities could go down in value in that time. They could also go up, of course."

To learn more about the benefits and risks of ETFs, read the Bankrate story, "Are exchange-traded funds dangerous?" by Constance Gustke.

 What do you think of ETFs? Do you have any or do you plan to own ETFs in the future?

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