This December, Invesco (IVZ) announced it would be liquidating 42 exchange-traded funds by February 2020, on top of the 19 it had already closed in February 2019, the largest closure wave since Barclays’ (BCS) iPath exchange-traded-note unit shuttered 50 products in 2018.
Given that there are more than 2,400 ETFs today, with 90% of assets at just five firms, investors should expect more such announcements from both large managers looking to trim the fat and small ones that can’t compete.
So what should you do if you receive a liquidation notice: sell immediately, wait for the liquidation, or carefully time your sales? The answer isn’t straightforward. Here is a rundown of what you should keep track of.
Maintaining your asset allocation. If you still want exposure to an ETF’s area, you’ll need to find an adequate substitute or hold on to the fund until it liquidates to maintain the exposure as long as possible. “In almost all cases, there are ETFs that are offering similar exposures [to the Invesco ones],” says Ben Johnson, Morningstar’s director of global ETF research. “There are a handful of exceptions that represent ideas whose time has come and gone.” For instance, there’s no natural replacement for (FXS).
For more-mainstream ETFs—such as Invesco’s suite of six single “factor” ETFs, which choose and weight stocks according to factors such as value, momentum, and low volatility—replacements are easier to find. “Even if you remain within the Invesco suite, we have a very positive view on Invesco S&P 500 Low Volatility (SPLV),” Johnson says. “It’s delivered on its low-volatility objective in a very cost- and tax-efficient manner.” This ETF could replace the liquidating Invesco Russell 1000 Low Volatility Factor (OVOL). Yet while their investment objectives are similar, the portfolios of the two ETFs are different. For instance, the Invesco S&P 500 fund is more concentrated and focused on midsize companies: It has 100 stocks with an average market value of $36 billion, versus the Invesco Russell 1000 fund, which has 275 stocks and an average market value of $150 billion.
“Investors should not just choose the largest or cheapest ETF that sounds the same,” says Todd Rosenbluth, head of ETF research at CFRA. “They’ll want to make sure they understand what they’re getting—what’s inside the portfolio, how often it is rebalanced—because each ETF in the [factor] space is likely unique compared to all the others.”
Tax consequences. Even if you find the perfect replacement, that doesn’t mean you should sell an ETF as soon as you learn it’s liquidating. Consider the tax consequences first. “When the ETF liquidation is announced, if the investor’s holding period is less than one year and the one-year anniversary from purchase date will occur before the ETF’s liquidation, the investor may want to consider holding on to turn a short-term capital gain into a long-term one,” notes Paul Winter, president of Five Seasons Financial Planning in Salt Lake City. Long-term gains are taxed at a maximum rate of 20%, while short-term gains are taxed as ordinary income, as high as 37%.
Further complicating matters is that during a liquidation, ETFs will distribute any embedded capital gains or income left in the portfolio, and if any of those are short-term gains, they will be taxed at the higher rate. Generally, if you’re facing short-term gains upon liquidation but can sell the ETF sooner for a long-term gain, that is the best move. If you’ve held the ETF for less than a year, or would sell at a loss, it becomes a more nuanced decision.
“Invesco will provide a breakdown of income, capital gains, and return of principal,” wrote Invesco spokesperson Stephanie DiIorio in an email, but she couldn’t provide a specific date for that disclosure.
Liquidity. The ability to sell a closing ETF is another concern. Most liquidating ETFs are small to begin with—historically below $50 million in assets—and consequently can be difficult to trade, with wide bid-ask spreads. They can also trade at a discount to their underlying portfolio value, especially before a liquidation, as more investors will be selling than buying. Selling at a discount means you’re getting less for your ETF shares than they’re actually worth.
A few days before liquidation, an ETF will often cease trading altogether. For 36 of the 42 liquidating Invesco ETFs, their last trading day will be Feb. 14, although investors won’t receive their liquidation value until Feb 26. During those final days, the ETFs “will not be pursuing their stated investment objective or engaging in any business activities except for the purpose of winding up their business and affairs, preserving the value of their assets, paying their liabilities, and distributing their remaining assets to shareholders,” says DiIorio.
Tracking error. As ETFs sell securities to raise cash for a liquidation, they can have significant tracking error with their chosen benchmarks, meaning you won’t have exposure to the ETF’s target sector during those days. In fact, for some managers the goal is to be in cash as quickly as possible. “Tracking is less of a concern,” says Matthew Bartolini, State Street Global Advisors’ head of SPDR Americas Research. “The goal is essentially that the value I, as an investor, could get in the market for the ETF [on its last day of trading] should be similar to the value I receive on its liquidation date.” That way, investors trapped in the ETF during those last days get no unpleasant surprises. If you have a substitution for a liquidating ETF, it might be wise to start building your position in that final period to maintain exposure.
If you want to avoid future liquidation hassles, stick to ETFs with more than $100 million in assets or to money managers that have a track record of supporting their ETFs even when they’re small. According to Johnson, Vanguard Group and Charles Schwab (SCHW) have never liquidated one of their ETFs, while BlackRock (BLK), State Street (STT), and Invesco often do. Still, with more than 2,400 ETFs now tracking every security imaginable—and more than 1,000 of those with less than $50 million in assets—it’s probably unwise to consider any tiny one safe from elimination.
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