Zombie ETF

Definition

A Zombie ETF (Exchange-Traded Fund) refers to an underperforming ETF that has low trading volume, limited investor interest, and minimal assets under management. These funds often struggle to generate significant returns and might be at risk of liquidation due to their lack of profitability. Investors should be cautious when considering investing in Zombie ETFs, as they may not provide desired diversification or risk-adjusted returns.

Phonetic

The phonetic pronunciation of the keyword “Zombie ETF” is:Zombie: /ˈzɒmˌbi/ETF: /ˌiːˈtiːˈɛf/Here, we have used the International Phonetic Alphabet (IPA) to write out pronunciation.

Key Takeaways

Zombie ETFs are exchange-traded funds that have a low trading volume and/or assets under management, which may lead to reduced liquidity for investors.
These ETFs tend to underperform in the market and are more likely to be closed by the issuers, thus adding an element of risk for those invested in them.
Investors are generally advised to avoid Zombie ETFs and consider alternatives that have higher liquidity, better track records, and more stable assets under management.

Importance

The term “Zombie ETF” is important in the business and finance domain as it refers to an Exchange Traded Fund (ETF) that is experiencing underperformance, low trading volume, and lack of investor interest, making its existence questionable. These ETFs are typically characterized by diminishing assets under management (AUM) and low returns, thus leading to higher expense ratios. The significance of a Zombie ETF lies in its potential risk for investors, who may face difficulties when trying to sell their shares due to reduced liquidity. Furthermore, they also serve as a cautionary tale for fund managers looking to launch new ETFs, emphasizing the importance of building a unique value proposition and garnering investor interest to avoid a similar underwhelming fate.

Explanation

Zombie ETFs, often known as “orphaned ETFs” or “dead ETFs,” typically serve a dual purpose in the financial markets. Firstly, they cater to niche areas and specialized investment strategies not serviced by primary market index funds or well-established ETFs. These exchange-traded funds aim to provide investors with unique exposure to alternative asset classes or sectors that are underrepresented in the more popular and widely-held ETFs. In essence, Zombie ETFs offer an opportunity for discerning investors to diversify their portfolios, capitalize on potentially untapped market spaces, and potentially earn higher-than-average returns. Secondly, Zombie ETFs serve as valuable tools for institutional investors and asset managers who are keen on exploiting low liquidity and higher spreads that are characteristic of these ETFs. Institutions with sizeable holdings can take advantage of these inefficiencies to execute large orders without significantly impacting the market price. Furthermore, Zombie ETFs can act as vehicles for tactical asset allocation, allowing fund managers to time their exposure to sectors and themes that they believe will perform better in specific market conditions. This ability to nimbly navigate the market landscape has the potential to enhance overall portfolio performance and can be an appealing attribute of Zombie ETFs for more sophisticated investors.

Examples

A Zombie ETF, or Zombie Exchange-Traded Fund, is an ETF with low trading volume, assets under management (AUM), and liquidity, which can result in high trading costs and lackluster returns. These are often called “languishing” or “struggling” ETFs.Here are three real-world examples of Zombie ETFs that were liquidated or merged due to lack of interest or poor performance: 1. VelocityShares 3x Long Crude Oil ETN (UWT): This triple-leveraged ETF, which aimed to provide investors with exposure to oil prices, was liquidated in April 2020 due to unprecedented fluctuations in the oil markets. The ETF had experienced low trading volume and assets under management, making it a prime example of a Zombie ETF. 2. WisdomTree Asia Local Debt Fund (ALD): This ETF, which aimed to provide investors with exposure to local currency bonds in Asia’s emerging markets, was liquidated in June 2018. The ETF had struggled to gather assets and saw limited trading volume, making it an example of a Zombie ETF that ultimately did not survive in the market. 3. Global X SuperDividend U.S. ETF (DIV): This ETF’s goal was to replicate the performance of the highest dividend-yielding securities in the United States. However, it faced challenges with low trading volume and assets under management, causing it to shut down in September 2020. It is essential for investors to carefully evaluate ETFs and their characteristics before investing, as Zombie ETFs might lead to poor returns or even the risk of liquidation.

Frequently Asked Questions(FAQ)

What is a Zombie ETF?

A Zombie ETF (Exchange-Traded Fund) is an ETF that has relatively low assets under management (AUM) and low trading volume, which may cause it to underperform or become illiquid over time. These ETFs typically fail to attract significant investor interest and have difficulty in achieving economies of scale.

What causes an ETF to become a Zombie ETF?

An ETF may become a Zombie ETF due to multiple reasons, such as launching in a saturated market, targeting a niche or unpopular investment strategy, poor marketing, or lackluster performance. As a result, the ETF struggles to gather assets and fails to generate significant trading volume.

What are the risks associated with Zombie ETFs?

Zombie ETFs can pose several risks to investors, including illiquidity, high bid-ask spreads, poor tracking of the underlying index, and the potential for closure. These factors can significantly impact an investor’s ability to buy or sell shares at a fair price and may lead to losses.

How can I identify a Zombie ETF?

To identify a Zombie ETF, investors should consider factors such as the fund’s assets under management (AUM), trading volume, bid-ask spread, and tracking error. A low AUM, combined with low trading volume and wide bid-ask spreads, may indicate that the ETF is a Zombie ETF.

How can investors avoid the risks associated with Zombie ETFs?

To avoid the risks associated with Zombie ETFs, investors should conduct thorough research on the ETF’s strategy, performance, and liquidity before making an investment decision. They should also monitor their existing ETF holdings for signs of deteriorating liquidity or potential closure.

Can a Zombie ETF recover and become successful?

Although it is relatively rare, a Zombie ETF may recover and become successful if its underlying investment strategy suddenly gains widespread popularity, attracting significant assets and trading volume. However, investors should not solely rely on the potential for a turnaround when considering a Zombie ETF.

What happens if a Zombie ETF closes down?

If a Zombie ETF closes down, the fund’s sponsor will typically liquidate the assets in the ETF’s underlying portfolio and distribute the proceeds to the shareholders on a pro-rata basis. While the closure process is usually managed efficiently, investors may face additional costs and potential tax implications.

Are there any alternatives to Zombie ETFs for investors interested in certain niches?

Investors interested in niche or specialized investment strategies may consider alternatives to Zombie ETFs. These may include actively managed mutual funds, individual stocks or bonds, or other types of ETFs with a similar investment focus but with better liquidity and performance characteristics. Conducting thorough research and considering factors such as liquidity, fees, and performance can help investors make well-informed decisions.

Related Finance Terms

Financial Distress
Low Trading Volume
Underperforming Assets
Exchange-Traded Fund(ETF)
Liquidation Risk

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