ETF shakeout seen at hand

In the biggest shakeout thus far, 25 exchange traded funds already have closed this year, indicating that this fast-growing sector of the fund industry may be settling down. But while analysts agree that the industry may be growing up, they say that it is far from being mature. "I think there is a [larger] shakeout to come, but I don't know when," said Dan Culloton, fund analyst at Morningstar Inc. of Chicago. "I don't know if these [25 closures] are a pothole or a sinkhole. I think there are a lot of ETFs out there that won't exist in the coming years, because they were bad ideas or sponsored by people who don't have the staying power to see these funds get to a critical mass." Mr. Culloton added: "But I'm not seeing it as a mature industry yet. The bloom may have come off the rose a little because of the market." The closures are typical for a new industry, said Jim Lowell, Needham, Mass.-based editor of Forbes ETF Advisor. "It's not because the industry is maturing," he said. "It's exactly the opposite. It takes 10 years to get in the spotlight. Then there's a stampede. "There's plenty of growth to come," Mr. Lowell added. Still, more closures loom. "We'll see more closures if the bear market is protracted," Mr. Lowell said. "You may see an ETF family or two go under. It's not just because there has been a bear market; it's also because it's become more confusing for investors to sort through all the ETFs out there." ETFs typically close if they have trouble attracting assets, Mr. Lowell said. While some funds closed this year, another 150 were launched, said Matt Hougan, editor of New York-based IndexUniverse.com, which provides research and analysis on ETFs and index funds. "Maybe ETFs have come home to roost a little bit," he said. "But I think there is huge growth ahead." Large firms will continue to enter the market, Mr. Hougan said. For example, Pacific Investment Management Co. of Newport Beach, Calif., has filed an exemptive-relief application for a bond ETF — the first step in launching a product. And there aren't any signs of a slowdown in investor interest. "The first half of this year, total assets under management fell by $50 billion because of the market," Mr. Hougan said. "At the same time, investors poured $23 billion into the ETF market." The closures do not mean that growth will stop, said Ted Toal, senior partner at Triton Wealth Management Inc. of Annapolis, Md., which has $90 million in assets under management. "I think ETFs definitely have room to grow," he said. "But it's typical Wall Street to take it to the extreme. There are so many different products and different indexes being created to attract money. A lot of advisers aren't interested in these weird ETFs — ones that are isolated or concentrated in obscure types of listings." But some advisers think the market is getting saturated. "Because they track an index, you can only do so many things," said Greg Zandlo, president of The Zandlo Financial Group of Minneapolis, which has $50 million in assets under advisement. "You can only slice the cookie so many different ways." Challenges remain for new entrants. With leaders such as The Vanguard Group Inc. of Malvern, Pa., State Street Global Advisors of Boston and iShares, the ETFs offered by Barclays Global Investors of San Francisco, adding value is a challenge for others, Mr. Culloton said. "Other firms can't match the [lower] expenses that the huge institutions offer," he said. "With ETFs, you have to pay trading spreads when you buy and sell," Mr. Hougan said. "For smaller funds, it's less liquid, and it costs more to buy and sell." Growth opportunities remain in actively managed ETFs, and "especially if they can crack the 401(k) space," Mr. Culloton said. "What everyone is looking for is the post-dot-com slaughter of funds," he said. "I don't think that will happen. But there could be some major ETF earthquake around the corner, and that wouldn't surprise me either." E-mail Sue Asci at sasci@investmentnews.com.