What Is a Zombie ETF?
I'm here to explain what a zombie ETF is—it's an exchange-traded fund that's stopped growing and isn't pulling in money from new investors anymore. Once it hits this zombie stage, you can bet it's only a matter of time before the issuing company shuts it down.
If you're an investor in one of these, you'll get your money back, or at least most of it. That said, you might end up with less profit than you expected, and you'll have to pay taxes on any gains from the fund.
Key Takeaways
- The popularity of ETFs has led to a flood of niche offerings, some of which fail to catch on with investors.
- A zombie ETF has stopped growing and taking in new money for the company that issued it.
- When a zombie is killed off, investors in the fund get cashed out. They will owe taxes on any profits for the year in which the payout was received.
Understanding the Zombie ETF
You know how ETFs have exploded in popularity? That's created a ton of niche options out there. Some just don't stick with investors, or maybe they were linked to a trend that's fizzled out.
These zombie ETFs show that the market is oversaturated. As of 2022, Statista reports there were 8,754 ETFs available, so it's no surprise some turn into zombies.
How ETFs Work
Let me break down ETFs for you—they're investments built to copy the makeup and performance of a specific market index or sector. Unlike many mutual funds, they're not actively managed; stocks get bought or sold only to match the index, and their shares rise or fall with it.
The big ones track broad indexes like the S&P 500. Others focus on sectors like oil, cloud services, or emerging markets.
Zombie Territory
There's no strict rule for when an ETF becomes a zombie or gets closed. Some issuers give new funds time to build interest, while others pull the plug fast based on how other funds are doing.
As a rule, if a fund hasn't seen inflows for two or more quarters in a row and trading volume is low, the issuer is probably considering shutting it down.
Once in zombie territory, these ETFs are more likely to close than revive. Closures used to seem like failures, but now they're viewed as positive—clearing out the junk and helping managers learn for better future ideas.
What Makes a Zombie?
ETFs appeal to individual investors because they match mutual fund or pro manager results but with lower fees—industry average is 0.45% for ETFs versus 0.16% for managed mutual funds, though competition has narrowed that gap.
Funds that can't attract new money spiral down. Low trading volume raises liquidity worries, scaring off investors, and admin costs eat into the issuer's profits without new capital.
You might judge an ETF by its returns, but the issuer looks at business profitability. That's why some get labeled zombies and closed even if they've delivered good returns.
How Do I Spot a Zombie ETF?
Check the numbers directly. Low assets under management (AUM) means it's not drawing investor interest. Low trading volume signals the same.
It's not about the ETF being good or bad—if it's not attracting enough attention, it's on the path to zombie status.
Why Are There Zombie ETFs?
Zombie ETFs aren't rare anymore. Broad, popular ones like the SPDR S&P 500 ETF Trust (SPY) have taken most of the market, leaving little room for others.
Providers are pushing quirky ideas to stand out and expand their lines, leading to hyper-focused ETFs in niche areas, like the Global X Millennials Thematic ETF (MILN) targeting companies relevant to young Americans.
These might have solid returns, but they're not automatic choices for portfolio diversification. The key is whether they meet a strategic need for enough investors.
What Is an Example of a Quirky ETF?
Quirky ETFs chase hot trends but can crash when the trend ends, turning into zombies.
Take The Obesity ETF (SLIM), which invests in biotech, obesity diseases, and Weight Watchers. Or the HealthShares Dermatology and Wound Care ETF, which shut down in 2008 from lack of interest.
Are Thematic ETFs at Risk of Becoming Zombie ETFs?
Thematic ETFs target megatrends like AI, blockchain, or alternative energy in 2023—seen as transformative and profitable.
They won't match the AUM of S&P 500 trackers, but that doesn't doom them to zombie status. Some perform well for investors wanting diversified exposure to hot areas.
Like all investments, there are winners and losers.
The Bottom Line
Holding a zombie ETF isn't disastrous. It's called a zombie not because it's losing money, but because it can't attract new investors steadily.
Worst case, the issuer closes it, and you get most of your money back. Then, reinvest in a lively ETF with solid trading volume and AUM showing demand.
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