700 ETF Closures / World Market ETFs Gain Ground

Many things require regular pruning to remain healthy, and the U.S. ETF industry is no exception. Today (March 22, 2017) is the last day of trading for seven WisdomTree (WETF) ETFs. Their impending delisting and liquidation pushes the tally to 700 ETF closures. Much like the 500-closure and 600-closure milestones, this one was both needed and expected. Additional such milestones are inevitable, and we will probably see a day when the number of closures becomes larger than the quantity of ETFs that are still listed for trading.

The ETF pie is large and growing. Not surprisingly, numerous asset managers want to get a piece of that pie. The barriers to entry remain quite low for the ETF industry—any firm with an idea and a little financial backing can bring a new ETF market. The recent SEC rejection of the Winklevoss Bitcoin ETF might prompt me to qualify “an idea” by changing it to “an idea involving regulated securities.” However, the fact remains that it is relatively easy to enter the ETF market, which is one of the reasons there is a proliferation of new offerings.

While the barriers to entry remain small, the barriers to success increase every year. Long gone are the halcyon years of “if you build it, they will come” for individual ETF assets. The industry is seeing tremendous growth, with assets doubling to more than $2.7 trillion in just a little more than four years. However, most of that growth is going to the large and established players. Additionally, these large players are exploiting their size by pushing fees lower, which helps them attract even more assets and creates another competitive advantage. Lower fees means it requires even more assets for a new ETF or sponsor to be profitable, increasing the barriers to success even further.

Some analysts believe it takes $100 million in assets for the typical ETF to be profitable for its sponsor. If true, then more than half (~54%) of all ETFs on the market today are not making money for their sponsors. Others put the break-even point lower. If it takes $50 million in assets to be profitable, then the number of products above this threshold improves to 1,092, making about 55% of them profitable. This of course translates to 45% being unprofitable, which is a very large percentage.

In terms of raw numbers, sponsors have launched 2,688 ETFs and ETNs in the United States. Today’s closures push the lifetime death toll to 703, leaving just 1,985 listed for trading when the markets open for trading tomorrow. This puts the ETF mortality rate at 26.1%—its highest level ever. As mentioned earlier, the number of closures will likely surpass the quantity still listed eventually, which will equate to a mortality rate in excess of 50%.

Yes, pruning is healthy, and the ETF industry has been ridding itself of deadwood on a regular basis. However, more thinning is still needed. With somewhere between 45% and 55% of existing products currently not turning a profit for their sponsors, it seems obvious that more closures will be forthcoming.

World Market ETFs Thrive at the Expense of the U.S.

Despite financial headlines proclaiming the largest market drop since the U.S. presidential election, many market segments posted improved momentum scores and price gains over the past week. World market ETFs made significant relative-strength advances by taking advantage of weakness in the U.S. dollar and domestic stock price declines.

Sectors: A slight majority of the Sector Benchmark ETFs posted momentum gains this week, most notably among the downtrodden and defensive sectors. The three sectors in the red are prime examples. Telecom and Real Estate each posted an 11-point momentum gain. It wasn’t enough to bring them out of the red, but impressive in the face of broad market losses. The third, Energy, continues to be by far the worst-performing category, but if you look closely, you can see that it reduced the magnitude of its negative momentum this week. Others posting improvements were Utilities, Consumer Staples, and Materials. Each of these climbed two spots higher in the relative-strength rankings. In the world of relative strength, there cannot be winners without losers. However, despite three sectors rising in the rankings, only one fell this past week. Financials plunged from second to eighth, passing by all three of the gaining sectors on its way down. Vanguard Financials (VFH) dropped 3.1% on Tuesday, and it is 6.4% below its March 1 peak. However, it is still up more than 18% since the election, so recent action is far from being a disaster. Still, owners should be monitoring the current pullback for signs it could turn into something worse.

Factors: None of the Factor Benchmark ETFs posted a momentum gain this past week. However, there was shuffling among the relative-strength rankings with four rising and five falling. Low Volatility and Dividend Growth climbed two spots higher, while Growth and Small Size each managed to move one rung upward. The five factors falling in the rankings were Quality, Market Cap, Fundamental, Value, and High Beta. High Beta has the distinction of being the first factor to slip into the red this cycle. Additionally, just five weeks ago, it was completing a multi-month reign over the top of the rankings. Nothing lasts forever, and sometimes when the time is up, the exit is not very graceful.

Global: All but one of the Global Benchmark ETFs gained momentum, which is quite a contrast to the complete lack of momentum gains among the factor categories. As alluded to above, the U.S. was the lone global category losing momentum. This resulted in the U.S. plunging from third to ninth and pulling World Equity lower too, since it has a U.S. weighting of about 54%. Currency fluctuations were behind most of this global shift. The U.S. dollar took a nasty spill a week ago when the Fed raised interest rates, and it dropped again on Tuesday. China has extended its stay at the top and is now joined by Emerging Markets, which climbed three spots to provide the challenge. EAFE, Latin America, and the U.K were the other global categories climbing in the rankings. Canada is on the bottom for a fourth week and remains the only major global category in the red.

The following Edge Charts are market momentum snapshots. They provide a quick and easy way to help you visually get a handle on the overall state of the market. With these charts, you can assess both the relative strength and absolute strength (momentum) of more than 30 global equity market segments. Please refer to the Edge Chart User’s Guide for further explanation.

Disclosure: Author has no positions in any of the securities mentioned and no positions in any of the companies or ETF sponsors mentioned. No income, revenue, or other compensation (either directly or indirectly) is received from, or on behalf of, any of the companies or ETF sponsors mentioned.


Note:
The charts above depict both the relative strength and absolute strength of various market sectors, styles, and geographic locations on an intermediate-term basis. Each grouping is sorted (top to bottom) by relative strength. The magnitude of the displayed RSM value is a measure of absolute strength, which is our proprietary method of measuring and reporting the intermediate-term strength as an annualized value.


“I always think of a show like a plant—a little pruning now and then keeps it healthy,
but you shouldn’t pull it out and chop the roots up.”

—Len Goodman, professional

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