A zombie exchange-traded fund (ETF) is an investment tool that has reached a stagnation point, failing to grow and attract new funds from investors. Once an ETF falls into this trap, it often meets its demise, being shut down by the issuing company. Investors usually receive their money back, though this might result in potential losses and tax obligations on any profits earned.
Key Takeaways
- The burgeoning popularity of ETFs has led to many niche offerings, some of which fail to gain investor interest.
- An ETF is termed a zombie when it stops growing and attracting new capital for the issuing company.
- When shut down, zombie ETF investors are paid out, and due taxes on annual profits may apply.
The Anatomy of the Zombie ETF
With the increasing popularity and proliferation of ETFs, many niche funds have emerged. However, not all these funds gained traction among investors, often leading to their demise. Statistically speaking, as of 2022, there were 8,754 ETFs in the market, underscoring a saturated space.
Understanding ETFs
An ETF is designed to replicate a specific market index or sector’s performance, operating with minimal management activity compared to mutual funds. Investments are made to mirror the underlying index closely, resulting in the fund’s shares fluctuating in sync with the index or sector they follow.
Recognizing Zombie Territory
There is no strict criterion for labeling an ETF as a zombie or determining when it will be shut down. Still, if an ETF shows no inflows for two or more consecutive quarters coupled with low trading volume, it is a sign of troubling times ahead.
Rather than bouncing back, zombie ETFs are more likely to be closed—a pragmatic choice to clear industry clutter. This helps issuers reconsider their strategies and conceive more robust investment ideas.
What Constitutes a Zombie?
Despite their popularity among individual investors and their lower fees compared to managed funds, ETFs that struggle to attract fresh investments can quickly go south. A fund not seeing new inflows becomes burdened with high upkeep costs, diminishing revenue for the issuing firm despite potentially solid returns for its investors.
Spotting Zombie ETFs: A Savvy Investor’s Guide
Thoroughly reviewing the numbers is vital. Check the assets under management (AUM) to see if an ETF is capturing investors’ interest. Low AUM and low trade volume are strong indicators of an ETF drifting toward zombie status.
The Emergence of Zombie ETFs
With major ETFs like the SPDR S&P 500 ETF Trust capturing a considerable market share, newer and quirkier ETFs have come into play. These EVTs focus on niche market segments and trend-driven sectors, sometimes leading to impressive but poorly diversified funds.
Examples of Quirky ETFs
Quirky ETFs often follow emerging investment trends, riding the wave until circumstances force them into oblivion. For instance, The Obesity ETF invests in companies working on biotechnology and obesity-related solutions, but investing in specialized areas rather than diversified sectors.
Risks for Thematic ETFs
While thematic ETFs belong to current megatrends like artificial intelligence or blockchain, their capacity to attract total assets like S&P 500 linked ETFs remains limited. These curated investments can be lucrative for informed investors yet pose risks if they fail to generate sustained interest over time.
Final Thoughts on Zombie ETFs
Owning a zombie ETF isn’t entirely perilous. The primary issue isn’t that it’s losing money but rather its struggle in continuous investor appeal. Should the issuing company shut the ETF down, investors stand a chance to reclaim their investment, allowing them to redirect funds into more promising ventures. Keep an eye out for active trading volume and healthy AUM to ensure a more grounded investment.
Related Terms: ETFs, niche ETFs, thematic investing, asset management.
References
- Statista. “Number of exchange traded funds (ETFs) worldwide from 2003 to 2022”.
- Investment Executive. “Understanding zombie ETFs”.
