This content is from: Portfolio

More ETFs Die as Survival of the Fittest Gets Tougher

For ETFs, survival of the fittest is getting tougher for both the innovators and for the me-too copycats.

ETFs are born and ETFs die. That’s just business as usual. —

But the ETF world has been shocked by the death of two complete — and completely different — fund families. They couldn’t have been more unalike, and they wiped out pretty much simultaneously.

The sudden death of the two shows that survival of the fittest is getting tougher, for both the innovators and for the me-too copycats.

Last Friday Russell Investments of Seattle announced that it was terminating 25 of its 26 relatively new and innovative ETFs. The ETFs will be delisted on October 16, with the expectation that their assets will be liquidated over the following week, the firm said. As of July 31 the 25 ETFs had about $310 million in assets, the firm said.

The one Russell ETF that will survive — the actively managed Russell Equity ETF (ONEF) — is a definite surprise to analysts because it hasn’t done well, with just $4.2 million in assets under management.

Russell got ONEF when it acquired Reno, Nevada–based U.S. One, an investment adviser with ONEF as its only ETF, in January 2011 for its exemption, which allowed Russell to enter the ETF business. By May it had launched the first six ETFs under the Russell brand name. But ONEF appears to be “merely just a carryover” from U.S. One, says Eric Dutram, the ETF strategist at Zacks Investment Research in Chicago.

The question, he said, is whether Russell is keeping ONEF alive to hold on to that exemption so it can come back in the future with a new lineup.

Dutram noted that in its press release, Russell said that it “will continue to focus on offering solutions in the actively managed, asset-allocated ETF space as part of its core capability in investment strategy management,” and he says he’s wondering whether they’re “hinting at some more active products down the line.”

Other analysts are wondering aloud as to whether Russell is holding on to ONEF because it intends to sell the exemption to another provider and get out of the ETF business entirely.

A Russell spokesman said in an emailed response that those kinds of comments from analysts “fall into our ‘we don’t speculate on strategic business plans until when or if there’s news to announce’ category.”

Analysts interviewed for this story say they will miss the Russell ETFs. “I thought they were great and innovative products. They brought new concepts into the ETF marketplace, instead of offering me-too products. However, that was apparently not enough,” says Ron Rowland, the chief investment officer of Capital Cities Asset Management of Austin, Texas, and the executive editor of the website, which is best known for its monthly ETF Deathwatch list.

When Russell rolled out its first six ETFs in May of 2011, Rowland noted that there were “more than 60” ETFs on the market based on Russell’s indexes, but from other sponsors.

With the introduction of its own ETFs, Russell had created “next-generation ETFs” that would help investors construct portfolios and manage risk because each would “track the performance of a corresponding Russell Investment Discipline index, which is intended to reflect the return patterns of a particular investment strategy,” Rowland said in May 2011.

For instance, the Russell lineup included low-beta and high-momentum ETFs based on the Russell 1000 and Russell 2000 indexes, as well as an aggressive growth ETF and a low price-to-earnings ratio ETF.

Dutram says he’s “kind of surprised” the Russell ETFs didn’t attract more assets because they have “interesting methodologies.” He also says he’s surprised they gave up so quickly.

Russell had announced a strategic review of its ETF lineup back on August 6, and it quickly became known that it had already laid off about 30 people on its ETF staff in San Francisco and New York City, so it was clear the news wasn’t going to be good.

But as recently as last week, it was widely expected that at least four of its ETFs would survive because they had succeeded in attracting enough assets: Russell 1000 Low Volatility ETF (LVOL), Russell Equity Income (EQIN), Russell Consistent Growth (CONG) and Russell 1000 Low Beta (LBTA).

The most popular of those was LVOL, which had $69 million in AUM, but its competitors have assets that made that pale, noted Ana Kostioukova, an analyst with IndexUniverse of San Francisco. PowerShares S&P 500 Low Volatility Portfolio (SPLV), with $2.4 billion in AUM, and iShares MSCI USA Minimum Volatility Index Fund (USMV) with $375 million, “handily beat LVOL in assets,” she said.

The other casualty — FocusShares — was pronounced dead by its board on August 6. All 15 of the Focus ETFs, based on Morningstar indexes and sponsored by discount broker Scottrade of St. Louis, Missouri, stopped trading last Friday and will be liquidated by the end of August, its board said. That group is seen as a failed Schwab copycat.

The Focus ETFs were “plain vanilla,” and didn’t really do anything special, says analyst Carolyn Hill, also with IndexUniverse. Launched in March of 2011, AUM were just over $100 million as of July 31, with the most popular fund — the broad-market Focus Morningstar U.S. Market ETF — still under $20 million, even though it had an expense ratio of just five basis points, “which made it the cheapest, but that was its only differentiating factor,” she said. With such low expense ratios, “the funds needed a high asset base to remain viable,” but “yearly revenues based on July 31 AUM would be just $141,000 — hardly enough to keep a company going,” she said.

That makes the Focus ETFs sound rather boring, but rival discount broker Charles Schwab did much the same when it launched its cheap, plain vanilla ETFs in November 2009 and “most have been really successful,” Hill said, crediting “the Schwab name and marketing team,” including its network of financial advisers.

In fact, Schwab’s U.S. Broad Market ETF is “a billion-dollar fund,” and with its other 14 ETFs, “not a single one” has less than $150 million in AUM, said Dutram.

Dutram believes that Scottrade “looked with envy at Charles Schwab and their wildly successful program as the model for their FocusShares lineup,” and with the Schwab ETFs as a “roadmap, undoubtedly expected an easy road with its own lineup of commission-free, low-cost index funds.”

Meanwhile, Rowland published his latest monthly ETF DeathWatch list on August 13. His list has “surged an astonishing 131 percent” over the past year, he noted.

“The ETF Deathwatch is growing faster than the ETF industry itself,” he said. “Just 10 new products came to market last month, while 24 ETFs joined the ever-long critical list,” he said. Only one ETF gained enough volume to escape the list, for a net increase of 23, he said. The overall count on his list is now 377, including 273 ETFs and 104 ETNs.

And, no, Rowland is not surprised by the announcements from Russell and FocusShares. He flagged most of the FocusShares funds in October 2011. He also added ten of the Russell ETFs to his list in December 2011 and another four in May of this year. (Rowland gives ETFs six months of lead time before adding them to the list if they’ve failed to attract assets.)

Related Content