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National Bank Financial reports that 89 ETFs have been launched so far this year as of June 30 with 24 closures, which suggests we could be in for a record year of delistings.Zolak/iStockPhoto / Getty Images

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The number of exchange-traded funds (ETFs) is rising consistently, surpassing the 1,200 mark in Canada this year, but not all of them sustain investor interest and some are forced to close as a result. For advisors and investors dealing with delisted ETFs, the goal is to redeploy the capital in the most tax-effective way while ensuring clients’ asset allocations remain intact.

There were a record 201 ETF launches in Canada in 2021, up from 173 in 2020, according to data from National Bank Financial Inc. (NBF). There were also 36 ETF closures last year, slightly below the record 38 closures in 2020. NBF also reports that 89 ETFs have been launched so far this year as of June 30 with 24 closures, which suggests we could be in for a record year of delistings.

The main reason providers close an ETF is lack of investor interest, says Daniel Straus, director of ETF research and strategy at NBF.

“The ETF industry in Canada is burgeoning with new launches all the time, so it’s not surprising that every once in a while, there will be some trimming as ETF providers consider what’s working and what’s not,” he says.

Mr. Straus notes that delistings don’t necessarily happen because it’s a down market. Rather, a product may be too narrowly focused, too complex, or in a sector that has fallen out of favour with investors.

For example, in January 2020, before the pandemic-induced market meltdown started, Canadian asset manager Evolve Funds Group Inc. shut a few of its niche investment funds, including Evolve North American Gender Diversity Index ETF as well as two cannabis ETFs amid a downturn in that sector.

“Often, these are products that were once popular and trendy,” Mr. Straus says of funds that close, adding the average age of an ETF that delists is about four or five years.

In many cases, depending on how long investors have owned the ETF, they don’t take a loss when a fund closes, Mr. Straus adds, as the stocks in the fund are still trading.

For example, Evolve North American Gender Diversity Index ETF was trading close to its all-time highs when Evolve Funds announced it would close the fund. Earlier this year, Horizons Active A.I. Global Equity ETF increased in value in the weeks after Horizons ETFs Management (Canada) Inc. announced in March that the fund would close in May.

“Termination risk isn’t really a risk in the sense of financial loss. It’s just a risk in the sense of annoyance, time, cost, and overhead,” Mr. Straus says, with some exceptions.

Investor interest must translate to profitability

Raj Lala, chief executive officer of Evolve Funds, says his team speaks to institutional and retail investors before launching an ETF. Still, sometimes, the interest doesn’t pan out once it goes public.

He says Evolve North American Gender Diversity Index ETF that closed in early 2020 was one investors seemed very keen on – as were two sustainable investing CleanBeta funds that closed earlier this year.

“With both of those [CleanBeta] products, we got to a point at which we just didn’t see enough interest from investors that could translate into assets down the road,” he says, adding that he was “shocked” the CleanBeta funds closed after about a year “because I actually thought that this was going to be one of our biggest product lineups.”

Mark Noble, executive vice-president of ETF strategy at Horizons ETFs, says ETFs need to be profitable to continue trading, and the break-even point for most in Canada is around $20-million in assets under management.

Many are under that amount because providers are still trying to attract investor interest.

“If you can’t maintain profitability after two years, it gets hard to rationalize keeping it open,” he says. “When we launch ETFs, we’re very committed to trying to make these products work.”

He says advisors should make it clear to investors that they will not be penalized by owning an ETF that closes as the assets are liquidated at their net asset value.

“The more difficult conversation is around, ‘Why did you invest in something that’s closing,’ and trying to explain why that strategy didn’t work out,” he says.

Taxes, timing exit, and allocation

Stefanie Keller, chief executive officer and certified financial planner at Stellar Wealth and Tax Solutions in Winnipeg, says advisors need to understand the potential tax and foreign currency impacts when an ETF closes.

She notes that there’s no tax impact if the fund is in a registered account such as a tax-free savings account or a registered retirement savings account. But there would be a tax impact – capital gain or loss – if the investment is in a non-registered account.

“That’s really what catches people off guard – when they have a taxable event that they were not planning for,” she says.

Ms. Keller notes there can also be a potential foreign exchange impact for an unhedged product if a fund closes in either a registered or non-registered account, which the advisor will need to consider in the client’s portfolio.

While she hasn’t experienced a fund liquidation for any of her clients, “that would be a difficult phone call to make,” she says, because it would mean “the investment strategy that I had recommended for them no longer fits in the industry.”

For advisors in this boat, Ms. Keller points to revisiting the client’s portfolio to ensure the asset allocation still aligns with the financial plan.

Dan Hallett, vice president of research and principal at Highview Financial Group in Oakville, Ont., says ETFs slated for closure will continue to be managed until they stop trading. In most cases, he says advisors and investors may wish to hang on to the fund until it’s officially delisted.

“Sometimes, waiting is not a bad thing, just to buy you some time to figure out what you’re going to do with the funds,” he says.

However, some may wish to sell the fund sooner, depending on the timing of the closure and whether the disposition will be at a gain or a loss.

For example, he says if the notice comes in November that the ETF is closing in January, an investor who has lost money on the product may want to trigger that capital loss before the new year.

That’s an assessment to make depending on tax details specific to the client, he says. Otherwise, it’s really just an issue of where to deploy the funds.

“If there’s purpose and thought put into building the portfolio and the way it’s designed, usually you’re not going to take [the proceeds] and do something vastly different,” he adds. “The first inclination is ... what else can we find to give a similar exposure that would meet all of our criteria?”

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