What is a Zombie ETF?
An exchange-traded fund (ETF) that has become a zombie is no longer expanding and drawing in new capital. An ETF’s detour into zombie territory and subsequent closure by the issuing company are frequently just a matter of time. The majority of investors’ money will be returned. However, they may gain less than they had intended, and whatever earnings they make from the fund will have to be taxed.
Knowing Your Zombie ETF
A deluge of specialized services has resulted from the adoption of ETFs. A few of them resonate poorly with investors. Alternatively, they could have been associated with a booming but now-fading market trend.
A sign of an oversaturated ETF market is zombie ETFs. By 2022, there were 8,754 ETFs available, according to Statista.
How ETFs Operate: Exchange-traded funds (ETFs) are investments designed to mimic the holdings and performance of a particular market index or industry. Their management is less active than that of many mutual funds. Stocks are only purchased or sold as necessary to track the index, and the value of their shares rises or falls in tandem with the index or sector.
The largest and most well-liked ETFs are linked to the most extensive and inclusive indexes, such as the S&P 500 Index. Others are linked to performance indicators for specific industries, such as developing markets, cloud services, or oil.
Infected Dead Zone
When an ETF is deemed a zombie, whether or not it will be shut down is not set in stone. While some issuers give new funds plenty of time to draw interest, others make snap decisions in response to the expansion of previous offers.
Generally speaking, there’s a significant possibility the issuer of an ETF is considering terminating it if it hasn’t experienced inflows for two or more quarters and the trading volume is low.
When ETFs enter zombie territory, they are more likely to go down than rise again. Closures, once seen as an admission of failure, are now viewed as beneficial for the industry and the issuing business since they clear the air of junk and enable asset managers to grow from their errors and develop new concepts.2.
For What Is a Zombie?
Because they may provide returns similar to mutual funds or professional investment managers but at a cheaper cost, exchange-traded funds (ETFs) are popular among ordinary investors. A managed mutual fund’s average cost ratio is 0.16%, whereas the industry average charge for an exchange-traded fund is 0.45%. The gap was much more significant before ETF competition drove managed funds to reduce their costs.
ETFs that need help bringing in fresh capital may see a decline. Investors may become wary of low trading volume due to liquidity worries. In the meantime, the issuing company’s profit margin is reduced by the expense of managing a fund that needs to draw in fresh money.
An ETF’s performance is determined by its return to investors. The profitability of the firm serves as the company’s gauge of success. Because of this, certain ETFs that provided solid returns for their investors were deemed zombies and shut down.
What Makes an ETF a Zombie?
Examine the figures. A low assets under management (AUM) figure suggests that investors must show more interest in the fund. A limited volume of trades presents the same.
The issue is not whether the ETF is good or bad. If not enough people are interested in it, it will end up in the zombie world.
What Makes Zombie ETFs Existent?
Zombie ETFs are becoming commonplace. Few opportunities remain to profit from since the largest and most well-known ETFs, like the SPDR S&P 500 ETF Trust (SPY), have mostly satisfied consumer demand.
Suppliers are coming up with more unusual ideas in this competitive environment to differentiate themselves from the competition, acquire market share, and expand their product offerings.
Consequently, some very targeted exchange-traded funds have invested in specialized markets. Take the Global X Millennials Thematic ETF (MILN), which is an ETF that invests in businesses that provide goods that appeal to the youth market in the United States.
These funds are not obvious choices for investors wishing to diversify their portfolios across industries, even if they may have high or even outstanding returns.
The actual test is whether a fund meets a strategic need in the portfolios of sufficient investors.
What Does a Quirky ETF Look Like?
Oddball ETFs often track popular investment fads. Regretfully, they can follow the trend to the very end, at which point they turn into zombie ETFs.
The Obesity ETF (SLIM), for instance, is invested in biotechnology, diseases associated with obesity, and, of course, Weight Watchers International.
Alternatively, the HealthShares Dermatology and Wound Care Exchange-traded fund was shut down in 2008 due to low investor interest.
Do Themed ETFs Run the Risk of Turning Into Zombie ETFs?
An ETF with a theme invests in popular megatrends that are both profitable and revolutionary. ETFs concentrating on blockchain technology, artificial intelligence, and alternative energy sources may be on the list in 2023.
The total assets under management (AUM) of a themed ETF will probably be smaller than that of an ETF linked to the S&P 500. That does not imply that it is approaching the realm of zombies.
Some will do very well for the knowledgeable investor who wants to invest in a trending region but still wants an ETF’s wide range of correlated assets. There will always be winners and losers in the financial world.
The Final Word
Investing in zombie exchange-traded funds (ETFs) does not spell doom. Its capital loss is why it isn’t referred to as a zombie. The reason it’s a zombie is that it can’t draw in new investors consistently.
In the worst-case scenario, the ETF’s issuing firm will shut it. Most of your money will be returned to you in such a system. The funds may then purchase an ETF exhibiting some genuine life. Seek an AUM figure that indicates strong demand and a relatively high trading volume.
Conclusion
- Numerous specialized products have emerged due to ETFs’ growing popularity, although not all of them are well-liked by investors.
- A zombie exchange-traded fund (ETF) has ceased to grow and generate fresh capital for the issuing business.
- Upon the demise of a zombie, fund investors get their money back. For the year the dividend was received, they will be taxed on any earnings.
