What is a 'Zombie ETF'

A zombie ETF refers to exchange traded funds that are seeing little trading volume or increased investment. These funds are described as zombies because they aren't growing and are likely to be cut by the issuer. In other words, the ETF may be dead already and just not know it. ETFs are like many financial instruments, in that a lack of new capital flowing in and/or trading volume in the shares can be a bad sign. The liquidity concerns with the low trading volume scares investors away even as the costs of administering a fund that isn't attracting new capital inflows erodes profitability for the issuing firm.

BREAKING DOWN 'Zombie ETF'

Zombie ETFs are not the only zombies in the world of finance. There are zombie banks, zombie debt and zombie titles. In finance, "zombie" is generally used to describe situations where capital is tied up without a clear path to resolution. Zombie ETFs also fall into this type of description in that the issuer has a fund that isn’t attracting new funds and isn’t seeing its shares trade in any significant amount. So the issuer is left holding a fund that costs money to maintain but has little prospect for growth. In this situation, it is usually only a matter of time before the issuer shuts down the ETF in question.

The Rise of Zombie ETFs

The main reason zombie ETFs are on the rise is that there are more ETFs being issued every year. The broad, popular ETFs like the SPDR S&P 500 ETF have filled much of the market demand, but there are new areas opening up in hyper-focused ETFs. The risk with this kind of experimentation is, of course, that a fund just doesn’t catch on with investors and joins the growing ranks of Zombie ETFs. The success of new ETFs isn’t even measured by returns, however, as some zombie ETFs have been shut down despite posting strong returns. The issue is whether a fund fits a strategic need in enough investors' portfolios. A targeted ETF can act as a market hedge or help diversify a portfolio, but it still needs to have a broad enough appeal that it is profitable for the company managing it.

From Zombie ETF to Dead ETF

Of course, there is no universal guideline on when a zombie ETF will be put down. Some issuers give a generous timeline for a new fund to season and start generating interest, while others are able to make quick culls based on the growth in other offerings. Exchanges have also played a role in the proliferation of ETFs and thus the rise of zombies. Exchanges are competing for new listings to add to an industry that has been a growth driver when other financial issues have dried up, and they aren't above incentives for new ETF listings. This can encourage issuers to let a zombie ETF linger longer than they would otherwise. If a fund hasn’t seen inflows for successive quarters and the trading volume is low, however, there is a good chance that the issuer has it in its sights, even if they aren’t quite ready to pull the trigger.

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