Lessons learned in the ETF graveyard

There are now 337 exchange-traded funds pushing up the daisies. More than 40 percent of those deaths by Darwin took place in the last 18 months, when ETF inflows have broken records. While ETF closures can be an inconvenience for investors in the short-term, in the long run they are healthy for the industry and investors. While some of the deaths are simply due to bad timing, closures help weed out weaker players and lead to higher-quality products. A recent article on the Index Universe web site said the rapid pace of closures “speaks more about an industry in growth mode than one in retreat.” A stroll through the ETF graveyard shows why some of the funds don't last. Here's a look at a few of the more famous defunct ETFs and the lessons we can take from their demise. HealthShares Emerging Cancer (HHJ), 2007-2008 This is the ETF that Vanguard's John Bogle loves to hate on. “Can you believe we now have an Emerging Cancer ETF?” Bogle wrote in a 2007 Wall Street Journal op-ed. He blasted the ETF again, five years after its closure, at a Morningstar conference in June. HHJ was one of 19 specialized health-care ETFs created by the now defunct XShares. Others included HealthShares Neuroscience and HealthShares Infectious Disease. The company said they weren't able to attract assets and that their “timing was bad.” Lesson: What may work in 2060 may not work now. PowerShares DB Crude Oil 2X (DXO), 2008-2009 This exchange-traded note closed with $425 million in assets, by far the largest ETN or ETF ever to close. Why? According to the press release, “limitations imposed by the exchange.” The Commodity Futures Trading Commission was worried about DXO owning too much of the crude oil futures market. This was baffling to some investors, since an ETF or ETN is not one big investor but a vehicle for many small investors. Lesson: Regulations affect ETFs, and reasons for closures can come out of left field. DENT Tactical (DENT), 2009-2012 This actively managed ETF turned off investors with its poor performance, confusing objective, high expense ratio of 1.49 percent and turnover of 456 percent. This is the sort of thing ETF investors thought they left behind in the mutual fund world. DENT collected only $6 million in assets before throwing in the towel in August of 2012. Lesson: No one likes to be overcharged for underperformance. FaithShares Christian Values (FOC), 2009-2011 This fund was one of a religiously responsible product line of ETFs created by Oklahoma City-based FaithShares Funds that failed to attract assets. After the funds closed, FaithShares found a way to use a valuable asset it still held -- regulatory approval from the Securities and Exchange Commission to issue ETFs. It renamed itself Exchange Traded Concepts (ETC) and now helps other, smaller companies that don't yet have issuer approval to get their ETFs out faster. Exchange Traded Concepts has helped seven ETFs come to market, including the $237 million Yorkville High Income MLP ETF (YMLP). It has many more on the way, including a filing for the first-ever robotics ETF, with the ticker ROBO. Lesson: People invest to make money. Guggenheim Airlines (FAA), 2009-2013 Many ETF pundits, including yours truly, are convinced this ETF could have made it if given the proper marketing love. It already had $21 million when it closed; the average closed ETF had $9 million. It was having a great year – up 24 percent in the first three months of 2013, compared to 10 percent for the S&P 500. It also had a great ticker in FAA (Federal Aviation Administration, anyone?). In addition, FAA, with its airline stocks, had an exploitable relationship with oil, since airline stocks typically go up when oil goes down, because fuel becomes cheaper. Yet it didn't seem like anyone was out there promoting it. Lesson: Even promising products can die without the right marketing muscle. iShares Diversified Alt Trust (ALT), 2009-2013 This closure surprised the ETF world. It was the first iShares ETF to close in over a decade. It had more than $50 million in assets, much more than some other iShares ETFs that the company kept open. But ALT was a costlier, more actively managed, hedge-fund-style ETF that invested in long and/or short positions in foreign-currency forward contracts and exchange-traded futures contracts. iShares said it saw little long-term demand and made the move to cut its losses. As the world's largest ETF issuer, iShares took some of the stigma and shame out of closing an ETF. Lesson: The big guys make mistakes, too. Focus Morningstar Large Cap (FLG), 2011-2012 FocusShares, a subsidiary of Scottrade, came into the ETF market like one of those "Price Is Right" contestants who bid one dollar more than the highest bid. FocusShares offered many of its ETFs at expense ratios one basis point less then the cheapest product. It offered many plain-vanilla products that already existed, such as U.S. small-, mid- and large-cap ETFs. Investors never warmed up to these “me too” products. Lesson: It's not enough to be the cheapest. Global X Fishing Industry (FISN), 2011-2012 The ETF that inspired such headlines as “Fishing for Profits” and “Don't Take the Bait” folded pretty quickly after attracting only $1 million in assets. This ETF had the bulk of its holdings in Japan and Norway, which are home to a lot of large commercial fishing, fish farming and fish processing operations. That narrowness may have doomed the ETF, but the timing of the launch didn't help. It came out right after the March 2011 earthquake, tsunami and Fukushima power plant disaster. The ETF lost 25 percent in its first six months out of the gate. If FISN had stuck around, it would have gained approximately 31 percent in the past year, thanks largely to the rally in Japanese stocks. Lesson: It's all in the timing. Eric Balchunas is an exchange-traded-fund analyst at Bloomberg. Bloomberg News