Exchange-Traded Funds are more popular than ever with total assets in U.S. markets approaching $5 trillion. At the same time, more ETFs are closing than ever before. In 2020 a record 275 ETFs closed their doors. What is going on?

Companies late to the ETF game must distinguish themselves from their competition, and it’s too late to launch an ETF in a well-established area. For example, launching an emerging market ETF at this point will likely fail because those interested in that area gravitate to the popular iShares Emerging Markets (EEM) or Vanguard Emerging Markets (VWO). Wisdom Tree China closed its doors last year because investors who want to invest in China buy iShares China (FXI), which has a 17-year track record and $4.3 billion in assets.

For investors, it’s more attractive to trade ETFs with a lot of volume, and those with a lot of assets under management generally also trade actively.

Most companies that are now launching ETFs are targeting a very specific and narrow marketplace. In many cases the ETFs are so specific that most investors don’t understand the product. Count me in that category. For example, one of the ETFs that recently closed was the AGFIQ U.S. Market Neutral Momentum Fund. Most investors didn’t know (or care) what that fund was all about.

At this stage, a provider must introduce a “story” ETF in order to become popular. Those are narrowly focused in a particular area. An example of an ETF that successfully gathered assets is BlackRock U.S. Carbon Transition Readiness (LCTU). Actively managed ARK ETFs like Innovation (ARKK) and Genomic Revolution (ARKG) also became popular, as has their “star” Cathie Wood.

Some of the story ETFs are so narrowly focused that they struggle to find enough stocks in the industry to fill their portfolio. For the ARK Space Exploration & Innovation ETF (ARKX) the largest holding (Trimble Inc.) is 8.9% of the portfolio and the second largest holding is the ARK 3D Printing ETF (PRNT). That means investors are paying a management fee on the ETF and a management fee on the fund’s second largest holding. Is that even legal?

Not all story ETFs become popular. JP Morgan Event Driven ETF and Goldman Sachs New Age Consumer both failed to gather assets and shuttered. Although there is no risk to investors when a fund closes, the liquidation of a capital asset (stock or fund) could have tax implications if the ETF is held outside of an IRA.

Does all this mean the ETF market is oversaturated? The quantity of ETFs may be near a peak, but total ETF assets continue to rise. The big ETFs are getting bigger, in part due to market appreciation, and many of the small ETFs are closing. For investors, that’s mostly a good thing.

David Vomund is an Incline Village-based Independent Investment Advisor. Information is found at http://www.VomundInvestments.com or by calling 775-832-8555. Clients hold the positions mentioned in this article. Past performance does not guarantee future results. Consult your financial advisor before purchasing any security.