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Learning From ETF Closures

My colleague Paul was spot-on with his recent blog describing how ETF fund closures are healthy for the industry in terms of competition and the state of the overall market.

Still, we should still remain critical and try to learn some lessons from fund closures, particularly given the slew of funds-a total of 40-that FocusShares and Russell decided to shut in the past month.

One concern I have is the potential for the wrong perceptions that may circulate as people process the amount of fund closures we've witnessed this year.

Those that are willing to do a quick Google search may think that the 69 fund closures this year is an alarmingly high number, but far fewer will grasp that the number means next to nothing for an industry still very much in a growth mode.

After all, as Paul pointed out, U.S.-listed ETF assets hit a new all-time high last week of $1.24 trillion. It doesn't sound like a dying industry to me.

Still, many who haven't begun to grasp what a huge and important innovation the ETF is, may end up interpreting a surge in fund closures as a sign of some major flaw in the ETF industry.

This certainly isn't the kind of attention that the industry should attract, especially before what is expected to be a new influx of assets from 401(k) plans and other defined contribution retirement accounts.

To better manage perception, issuers-both new and established-need to do more to lower the risk of fund closure.

The point is they are falling short of nurturing and seeing their funds through.

FocusShares' Lack Of Focus

The shuttering of FocusShares' entire lineup of 15 ETFs is probably the most disconcerting to me.

Sorry Paul, I don't think a me-too group of funds targeting common investment themes was the issue here.

FocusShares had a great idea-offer broad exposure to U.S. sectors at super cheap prices.

Where the company failed was in utilizing its parent company, Scottrade, in promoting the products.

FocusShares also fell short in making sure the lead market maker on the funds did its job correctly from the outset and on an ongoing basis.

If you don't believe me, take a look at a firm that did do and continues to do its job correctly-Charles Schwab.

When Charles Schwab came into the ETF space in November 2009, it brought no new ideas to the table. Sorry, that's the truth. Schwab offered funds that tracked well-known and widely followed indexes at prices that made Vanguard, the king of inexpensive funds, blush.

However, the company was clearly determined to put its distribution channels to use.

If I were to walk into a Schwab brokerage firm today to open an account, there's no way I wouldn't hear about the company's ETF offerings. It helps that I can trade Schwab ETFs commission free in a Schwab account.

That's precisely why Schwab's ETFs boast of more than $7 billion in assets today. In other words, the firm proved that the "first to market" advantage so many people talk about in the fund industry doesn't always hold true.

The Perils Of Throwing Spaghetti

Russell, meanwhile, threw a lot of spaghetti at the wall. It rolled out 25 funds in rapid succession last year, and all 25 are headed for the ETF graveyard less than 18 months into the project.

Everything from high-beta versions of the Russell 1000 to high-momentum versions of the Russell 2000 were on the company's menu. However, Russell may have bitten off more than it could chew, falling short of delivering a distilled message of why its funds mattered.

For example, its low-volatility products, such as the Russell 1000 Low Volatility ETFs (NYSEArca:LVOL) were valid options for investors in these markets environments -especially considering their pricing relative to competitors with similar strategies.

Russell could also have pushed for tighter spreads on its products, and sought to minimize trading costs for investors.

I firmly believe that devoting more time and greater effort would have brought a different outcome.

Paul may be right in saying that investors have become a bit more sophisticated in their fund selections. However, some of these offerings were great tools for investors, and now those products are off the market.

Again, in my opinion, the burden is on issuers to see their products through, to really make clear to investors what it is they're serving up and why it matters.

At the same time, newcomers as well as established issuers need to be mindful of what they bring to market.

At the end of the day, fund closure isn't a major issue, but the inconvenience factor and the unnecessarily negative publicity it brings are problems that could be and must be prevented.

At the time the article was written, the author had no positions in the securities mentioned. Contact Ugo Egbunike atuegbunike@indexuniverse.com.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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