Investment Strategy

All ETF investors need to read this

Fund managers are constantly creating new investment funds as they scrabble around to attract assets and earn fees. Some are successful, others aren’t. Inevitably many get closed down. What can you do to reduce the risk of owning ETFs that get closed down? And if a fund you own is suddenly set for closure, what should you do?

An OfWealth reader wrote to me concerned that an exchange traded fund (ETF) that he’d invested in is being closed down. (Note: for the avoidance of doubt, this was not a recommendation made by OfWealth.)

Dear Rob,

I got into the RBL ETF because it had the lowest fees and the highest dividend, simply following [Name Withheld’s] advice issued in 2016 to get into one of them Russian ETFs, because they were cheap and reversal to the mean would make it a profitable investment for the truly patient investor.

I now read that the RBL ETF will be closed down together with 11 other ETFs from the same issuing entity, because the ETF money outflow has made them all uneconomical to run.

My question to an experienced professional: I see on the issuer’s website that the NAV net asset value is higher than the now listed stock exchange share price. The funds will be terminated somewhere end July.

Should I sell before that date, or should I do nothing and hopefully get the higher NAV paid out on my bank broker account ? What is usually done in such events, since I haven’t been in such a situation up until now with my investments?

That is all I want to know, and hopefully you can find some time to share what is usually the best way to handle such a situation.

Kind regards,

Alain

“RBL” is the SPDR S&P Russia ETF (NYSE:RBL), which tracks an index of Russian stocks. It was launched on 10th March 2010.

By coincidence I happen to like the Russian stock market at the moment because it’s extremely cheap and has a high dividend yield (see here for more). But what I’ll talk about applies to all ETFs in general.

Alain had the right idea when he selected the Russian ETF with the lowest fees and highest dividend yield among those available. Unfortunately, RBL hasn’t stayed big enough to make it an attractive prospect for the fund manager.

Why ETF size matters

As of 12th July 2017 RBL had total net asset value (NAV) of just $26 million (US dollars). NAV is the total value of all the securities and cash assets owned by the ETF. Fees run to 0.59% a year, implying top line fee income for the fund manager of just $153,000 or so. That’s probably not even enough to cover overhead costs, hence the decision to shut it down.

ETFs issue shares which investors can then buy and sell in the market like any other stock. There’s a broker appointed who ensures there are enough shares to meet investor demand.

As demand for the ETF goes up, more shares are issued and the cash raised is invested in the underlying stocks by the fund manager. If demand collapses, and loads of investors pull out their money, then some of the underlying investments are sold and some of the ETF shares are cancelled.

In this way the NAV (total size of the ETF) is constantly adjusted, not just due to fluctuations in the market price of the underlying investments, but also due to the number of ETF shares that exist. Here’s a chart of how RBL’s total NAV has changed since it was launched in March 2010.

RBL’s NAV peaked around $169 million in March 2011, a year after launch. That coincided with a rise in Russian stocks of around 30% during that year, and plenty of investor interest.

Russian stocks then fell hard during the rest of 2011 and were in a bear market until the end of 2015. You can see how RBL’s NAV collapsed during 2011 and never recovered.

After about four years with NAV kicking around the $20-30 million range the managers have finally decided to wind it up. RBL will be closed to new investors on 25th July and liquidated on 31st July.

There’s no hard and fast rule to how big an ETF has to be for it to survive. I tend to set an absolute lower limit of $50 million NAV, but I’d prefer the number to be above $100 million. So long as it fits your investment aims and the fees are competitive, bigger tends to be better.

These days my preferred Russian ETF is the iShares MSCI Russia Capped ETF (NYSE:ERUS). Even with Russian stocks being so out of favour at the moment ERUS has NAV of $471 million.

Given fees of 0.64% per year that would work out as total fees of $3.0 million per year. That’s more than enough, and actually pretty impressive given that it was only launched in early 2015, and that Russia isn’t exactly fashionable as an investment destination. It seems that iShares did a much better job of marketing ERUS to investors than SPDR did with RBL.

(By the way, the “Capped” in the name simply means that no single stock can exceed 30% of the underlying investments. Currently the largest is Sberbank (PINK:SBRCY), at 18% of the NAV.)

Even bigger still is the Van Eck Vectors Russia ETF (NYSE:RSX), which has current NAV of $1.9 billion, and almost the same fee rate as ERUS at 0.65%. This one’s been around for a decade, so it’s even more established. (For why I slightly prefer ERUS to RSX these days see here.)

Make sure you remember this. To reduce the chances of getting caught by a fund liquidation you should stick to larger, more established funds. Total NAV of the ETF is the first thing you should check before you invest.

Even so you can still get caught out. RBL once had NAV of $169 million, and few people would have spotted the subsequent collapse. So let’s turn to what to do.

Should you wait for liquidation or sell now?

Alain said he noticed that the RBL ETF is trading at a discount to NAV. Given that, should he wait for liquidation or sell out now?

This sounded strange to me as ETFs shouldn’t have large price discounts or premiums. There’s daily transparency about what they own, unlike for most closed-end funds. So if any significant discrepancy opens up then professional “arbitrage” traders should eliminate it pretty quickly.

I checked on the RBL website and found that the NAV per share was $18.76 on 12th July and the closing market price was $18.87. So, in fact, the shares were trading at a slight premium to NAV of 0.6%.

But Alain said he had seen a difference. I think what may have happened is he saw the total NAV figure for the whole fund, which is $26 million, and understandably mixed it up with the figure for NAV per share, which is $18.76. These websites are densely packed with lots of numbers and the font size is very small. In any case, there’s no major discrepancy now.

Given that selling the ETF shares will incur dealing costs, and the liquidation is in two weeks, I recommend holding on.

In the meantime there’s still the risk of a market fall. But I’m assuming AV wants to stay invested in Russia.

So if RBL falls then so will other Russia funds. The best move is to wait for the liquidation and then use the cash received to buy another Russian stock ETF, such as ERUS. You can’t avoid paying another buyer’s commission in this situation, but at least the commission to sell the original ETF is avoided this way.

It’s annoying when fund managers close funds that you’re invested in. It takes up your time working out what to do, and there’s some element of dealing cost. But you can reduce the risk of it happening by sticking to larger and more established funds.

However, if it does happen to you then use the time until liquidation to look for a new place to invest the cash that you’ll receive.

Stay tuned OfWealthers,

Rob Marstrand

robmarstrand@ofwealth.com


Previous ArticleNext Article

Rob is the founder of OfWealth, a service that aims to explain to private investors, in simple terms, how to maximise their investment success in world markets. Before that he spent 15 years working for investment bank UBS, the world’s largest wealth manager and stock trader with headquarters in Switzerland. During that time he was based in London, Zurich and Hong Kong and worked in many countries, especially throughout Asia. After that he was Chief Investment Strategist for the Bonner & Partners Family Office for four years, a project set up by Agora founder Bill Bonner that focuses on successful inter-generational wealth transfer and long term investment. Rob has lived in Buenos Aires, Argentina for the past eight years, which is the perfect place to learn about financial crises.

Leave a Reply