ETFs Profitability Question

ETFs Profitability Question

MaxRottersman @ maxdatabook.com

Is it possible that in a harsh market downturn many ETFs would become unprofitable? If so, how many, why?

This analysis is based on old data. Since mid-2018, for reasons beyond my comprehension, the S.E.C. has stopped collecting standardized expense data for 1940-Act funds.

In my previous report I mentioned that there are over “700 ETFs in a profitability challenged group”. Let’s refine that.

In order for any company to be a going concern it must be able to pay the operational expenses core to its business. If you’re a hotel, you need to pay for house-cleaning labor. There is no way to be in the hotel business without incurring that expense.

For ETFs, I assume that they all must pay custodian, registration, auditing, legal, printing and other fees. Understand that many of them don’t break out these fees; they’re often included in one unitary management fee. Fortunately, there are many ETFs that report operational expenses for their shareholders. We can use these funds to estimate their minimum operational costs.

I selected 189, open-end type, ETFs that broke out their fees in 2017 in form N-SAR (which the S.E.C. has replaced with an abbreviated form N-CEN*). My quick estimate is that most ETFs incur at least $85,000 a year on average in operational expenses, depending on characteristics such as whether they hold actual assets or synthetics, the type of asset (fixed income, global equities etc.) and whether the fund is part of a series trust or stand-alone.

Often, these expenses are reimbursed by the advisor. Again, what is being internally reimbursed, by whom and why, across the industry, is impossible to ascertain, especially for funds that don’t itemize their expenses.

613 Exchange Traded Products (ETFs/ETNs) that collect less than $85,000 in fees, potentially fall into this ‘sub scale’ category.

Assuming that any ETF with above $100 million has a good chance of being, or becoming, viable, I’ve filtered the dataset to 1,237 ETF under that amount.

Next, let’s calculate how much these ETFs would collect in fees if they had a 30% reduction in AUM.

How can an investor trust that their fund is being managed with due care if the numbers aren’t available? How can anyone determine how much money is coming from revenues, and how much from other sources? Are these funds only hoping to gain enough assets to be profitable or are there hidden fees that make some of them profitable already?

Are the Reserve Funds a cautionary tale about the limitations of fund boards and the S.E.C.?

If the market had a 30% correction, it looks like 717 ETPs would be losing money. That’s another 100 funds. a 50% correction would add another 100 on top of that.

All that said, who knows the future! The markets may grow and there is no denying that ETPs have become popular with investors.

Max @ maxdatabook.com

Please note, this is a cursory study. There may be inaccuracies, not small. If you are interested in a deeper analysis please contact me through e-mail and we can set up a time to talk.

*Yes, there is data in N-CEN that wasn’t in the N-SARs; however, the fact remains that data that was once available in a standardized questionnaire is no longer.