Exchange-traded funds have enjoyed a good run with investors over the past few years. Even when markets and the funds they track have declined in value over the past 18 months, asset numbers have held up respectably in both North America and Europe. Investors appear to be heeding the message of ETF providers that most actively-managed mutual funds underperform their benchmarks and that ETFs can offer at least comparable returns with considerably lower management and transaction costs.

This conviction has sustained the sales of funds that track well-established indices such as the S&P 500, the Nasdaq 100 and the Euro Stoxx 50. But efforts over the past few years to develop more innovative exchange-traded fund products have met with greater resistance from investors. While in many cases the jury is still out on some of these ETF concepts, it's clear that at least in the current climate there is wariness of products that are too narrow to attract sizeable investment, and in turn cannot deliver on their promise of easy liquidity.

Take for example the HealthShares series of ETFs launched by XShares Advisers, comprising a series of funds tracking extremely specialised indices for various segments of the health care market, such as cancer and drug discovery tools. Last August, in the face of negative performance and inadequate asset gathering, XShares closed 15 of its 19 HealthShares ETFs. A revamp involving lower expense ratios failed to save the remaining for funds, which closed at the end of the year.

The problem of an inadequate asset base also seems to be affecting fundamentally-based ETFs, which use a range of measures such as cash flow or dividend yield as an alternative to the traditional market capitalisation weighting of most major indices and the ETFs that track them. Earlier this year Spa ETF closed all its fundamentally-based funds in Europe and the US; at the end of last week a big beast of the ETF industry, Invesco PowerShares, announced the closure of 19 of its 131 existing ETFs, including 12 funds that use the FTSE RAFI fundamentals-based methodology.

Many of the funds that have closed over the past year were launched with much fanfare at a time when ETF providers sought to penetrate further into the mutual fund market by developing extremely narrow indices with sometimes tortuous methodology to access highly specialised investment sectors. In the process they retreated from the simplicity of the basic ETF premise, and often its low-cost character too. The end-result was that the final selling point of the product, its liquidity, went too.

To be sure, some highly specialised ETFs in well understood markets continue to thrive - and some mainstream products have also fallen victim to the morose environment. Northern Trust, a latecomer to the market, pulled its entire Nets ETF range after it failed to gain traction. But at a time when any asset management product is a hard sell, providers need to focus on the qualities - simplicity, ease and low cost - that attracted investors away from mutual funds to ETFs in the first place.


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