Why would an ETF close its doors?

Often an ETF will fold if it fails to pull in enough assets to make running the fund profitable for the issuer. Competition in the ETF market is fierce and many outfits have launched funds that compete head to head with existing products on the market. It’s difficult to overcome that first-mover advantage.

Issuers also launch esoteric offerings that fail to garner much attention from investors. However, for many issuers, these exotic funds may still be worth the risk. Given the relatively low expenses of launching a new ETF, particularly for large firms that enjoy economies of scale, issuers can afford to take the chance.

A good rule of thumb to picking ETFs with staying power is to stick with those offerings that have at least $25 million in assets. That’s typically the breakeven point for ETF issuers.

Nevertheless, there will be occasions where you might hold shares of an ETF that is preparing to shut down. What should investors do in this scenario?

More often than not, it pays to sit tight.

When an ETF folds, the fund’s underlying holdings are sold and the cash is distributed to investors. Although there are costs associated with liquidating an ETF, the issuer generally covers those costs. Investors should receive the net asset value of their shares based upon their value the day the liquidation is executed. In reality, investors don’t lose money. Liquidation is generally handled in such a way that the value of the fund’s underlying securities will not be affected by the selling activity. Additionally, if the fund is focused on liquid securities, it probably didn’t hold enough of these securities to affect their value.

The worst consequences when an ETF shuts down are usually an unanticipated tax bill and an extra commission fee. When you receive the cash distribution from the liquidation, Uncle Sam takes his cut of any gains. And you’ll have to redeploy those assets, resulting in another fee from your broker.

But aside from that small haircut, there’s no reason to panic when an ETF folds.

What’s New

Two new funds launched last Thursday; PowerShares Senior Loan ETF (NYSE: BKLN) and Global X FSTE Argentina 20 ETF (NYSE: ARGT).

Global X FTSE Argentina 20 ETF is the first ETF to offer pure exposure to the Argentine market. Argentina’s market has grown alluring for investors seeking to expand their South American exposure beyond Brazil. But Argentina poses some unique risks; the market turns in huge growth one year and sharp contractions the next as the result of questionable economic policies.

Nevertheless, Argentina is a huge exporter of beef and wheat. The country recorded GDP growth of 9 percent last year as the government continues to transition to a more consumer-oriented economy, qualities which can be very attractive to investors. But for now I’d avoid this ETF. Not only does the Argentine government have a history of meddling in the market, the fund has a low trading volume.

In another first, PowerShares Senior Loan ETF offers investors exposure to floating-rate loans on which borrowers typically pay LIBOR plus an additional premium; in this case only loans that have a minimum spread of 125 basis points over LIBOR can be included. As LIBOR rises and falls, the loan payment rises and falls. Investors in funds of this ilk are largely shielded from shifting interest rates.

That built-in rate insurance makes PowerShares Senior Loan ETF an extremely attractive offering.