ETFs can close for many reasons. However, most ETF closures are due to asset size, where the definition of small can be interpreted differently depending on the overall size of the ETF sponsor.
Advisors should not panic if an ETF announces a closure. Historically, the process to close ETFs has operated very smoothly. Throughout the ETF space, new managers and new strategies can present some of the best investment opportunities, where advisors perform their due diligence on the strategy, not the size of the ETF.
With that said, most advisors will not consider an investment in a small ETF due to their concerns about closure. Using asset size as a determinant for investment can be an unfortunate exercise—this mistaken rationale believes that the ETF will lack liquidity. Hopefully at this point most advisors know that the liquidity of an ETF is based on its underlying holdings and not its trading volume.
While ETFs possess some similar attributes as stocks, their liquidity is not measured the same way. There could be legitimate concerns as the largest shareholder of a stock. To find liquidity, that shareholder would need to continuously lower the stock’s price until someone is ready to buy. The company that issued the stock does not stand ready to redeem at fair value. It’s different for an ETF, where its issuer does stand ready to redeem at NAV. A market maker’s cost to facilitate an ETF trade is simply the cost of moving the underlying securities.
While ETFs mostly trade at or near the indicative net asset value (INAV), they can also trade at premiums and discounts, with the latter often seen when an ETF announces its closure. This is mostly due to the fact that all of the trades are headed in one direction: selling. The market maker is the last person tying up capital, with hedging costs, waiting until the final closure date. The market maker incurs costs during this period, which are reflected in the amount of the discount.