When ETFs wind down

If you can’t find a good alternative, it probably wasn’t worth having in the first place

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Q: I received a notice that an ETF I own will be closed within the next few months. Is it better to sell it now or wait until the termination date?

–S.H.

A: ETFs are now available for just about every niche sector and exotic asset class, so it shouldn’t be surprising when some of these fail to attract investor dollars. If an ETF cannot attract enough assets to be sustainable within a couple of years, the provider may decide to shut down the fund.

ETF closures have been relatively uncommon in Canada, but this year has seen several death sentences. In June, BlackRock announced it will be shuttering six products, including the iShares Broad Commodity (CBR), the iShares China All-Cap (CHI), iShares Oil Sands (CLO) and the iShares S&P/TSX Venture (XVX). Earlier in the year Horizons also terminated its broad commodity ETF as well as couple of its leveraged ETFs.

What should you do if you learn that an ETF you own will soon be shut down? To help answer this question, I reached out to Mark Noble, ‎head of sales strategy, communications and public relations at Horizons ETFs.

First off, let’s be clear that an ETF closure is nothing like a company declaring bankruptcy and its stock going to zero: investors don’t lose their money. Instead, the provider gives notice that the ETF will be terminated on a specific date a couple of months in the future. It then immediately stops any new subscriptions, which means that if you try to buy shares of the ETF on the exchange your order will not be filled.

However, if you own the ETF already you can still sell your units at any time up to the termination date. That’s because ETFs, unlike individual stocks, don’t need an individual buyer on the other end of the trade. “Similar to other ETFs, there are designated brokers ensuring the ETF price remains close to its net asset value, minus a small spread,” says Noble. “However there will be no bid-ask spread for the investor to refer to, since no inventory will be posted for sale.”

And what if you decide not to sell your shares before the ETF’s last day? The units will be liquidated and you’ll receive the proceeds in cash.

In both cases, if you hold the ETF in a non-registered account you may be find yourself being forced to realize a capital gain or loss you weren’t expecting.

Sell now or sell later?

So if you own shares of an ETF that’s destined for the chopping block, what should you do? Are you better off dumping your shares immediately, selling them shortly before the termination date, or holding them to the bitter end and allowing them to be liquidated by the fund provider?

Noble says there is generally little difference between selling your ETF units now and waiting until the termination date. But he acknowledges that the language in the press releases can seem scary, since it sounds like the investor will receive less than the net asset value of the units. Here’s an example:

Any remaining unitholders of the ETF as at the Termination Date will receive the net proceeds from the liquidation of the assets, less all liabilities and all expenses incurred in connection with the dissolution of the ETF, on a pro rata basis.

While you might infer that the stragglers will be handed the bill for the cost of winding down the fund, this is unlikely. “This language is necessary from regulatory perspective, and there is always a slight risk that expenses may erode the final valuation,” Noble says. “But in reality this is rarely the case and the valuation the investor receives is reflective of the final net asset value. Fees and expenses tend to be accrued and paid daily so they’re borne evenly and long-term unit holders are not penalized by short-term traders.”

My guess is that most investors won’t be willing to take that chance and will choose to sell their ETF shares before the fund is liquidated. Now it’s question of when. “The biggest factor for the investor is whether they think that market movement will change between the announcement of the closure and the delisting,” Noble says. “In other words, will they make more money if they sell before the delist date or not?” Of course, this is nothing more than a guess. If you happen to hold an ETF of commodities or Chinese stocks, you have no idea whether it will be worth more on its termination date several weeks down the road. So you’ll need to resist becoming a market timer.

There’s one more reason to dump your ETF units before the termination date: “If you sell the ETF before the delisting you immediately get the cash proceeds from the sale,” Noble explains. “If you sell after delisting, you would not receive any cash proceeds for seven days.”

Remember, if you’re a long-term investor with a target asset mix, you’re probably going to replace the terminated ETF with another fund in the same asset class. You might just switch from CHI to the iShares China Index ETF (XCH), for example. If you hold either the iShares or Horizons commodity ETFs, you could go with a U.S-listed option. And if you can’t find a good alternative to your terminated ETF, well, that’s probably an indication that it was so narrowly focused it shouldn’t have been in your portfolio in the first place.

This article originally appeared on canadiancouchpotato.com.

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