More ETFs getting put on deathwatch

According to the Morningstar database, 471 exchange-traded funds have been shuffled off to the dustbin of history in the past five years. How do you know if an ETF is headed towards the Choir Invisible? And how much does it matter?

The growth in ETFs — and the assets in them — has been spectacular. ETF assets have soared to $2.5 trillion from $1.3 trillion in 2012, according to the Investment Company Institute, the funds’ trade group. New ETFs pop up every month.

And old ETFs expire regularly as well. As of the end of April, the ETF mortality rate was 26.2%, versus 23.8% a year earlier. (Open-end funds have about a 20% mortality rate.) Last month, 12 ETFs shuffled off this mortal coil, according to ETF Deathwatch, an online monitor of ETF closures. The website currently has 466 ETFs and exchange-traded notes on its deathwatch.

The criteria for being placed on the deathwatch: Average daily volume that is less than $100,000 for three consecutive months, or assets under management below $5 million for three months. ETFs younger than six months are excluded.

The current deathwatch has 466 ETFs and ETNs. Of those, 430 have had one zero-volume day, and 13 had no trades in April. Some funds do rise from the deathwatch — nine did last month, as their assets or trading volume improved — but the funds on the watch have other problems.

The first problem is that the funds can trade for significant discounts to their net asset value. Consider DB Agriculture Short ETN (ADZ), which currently trades at 1.73% below its net asset value. In contrast, SPDR S&P 500 ETF (SPY) sells at a 0.02% discount.

Deathwatch members have other problems, said Ron Rowland, portfolio manager at Flexible Plan Investments Ltd. and curator of the list.

For one thing, you could have problems buying or selling a deathwatch ETF, just as you might with a thinly-traded stock. You could get a wide bid/ask spread, for example. In the case of DB Agriculture Short ETN, the bid Wednesday on Fidelity’s discount brokerage was $16.25 per share, while the ask was $33.90. (For comparison purposes, there was a one-penny bid/ask spread for SPDR S&P 500 ETF.

Should the ETF liquidate, you could have other headaches, Mr. Rowland said. For example, you could be charged closing expenses or fees on liquidation. You could also be shut out of your investment between the delisting date and the liquidation date. Or the sponsor could simply delist the security without liquidation, leaving it to trade on the so-called pink sheets.

The VelocityShares 3x Long Crude Oil ETN (UWTI) and the VelocityShares 3x Inverse Crude Oil ETN (DWTI) did just that in December. “There’s no bid/ask spread wider than what you’ll experience trying to unload something on the pink sheets,” said Ben Johnson, director of global ETF research for Morningstar.

Finally, you could get some unexpected tax bills if you’re stuck with a liquidated ETF, said Mr. Johnson. “If the ETF had appreciated in value and was held in taxable account, you could be on the hook for a capital gains bill you would have preferred to defer,” he said.