At the time of writing, the Canadian exchange-traded fund market houses 1,975 tickers – a smorgasbord of products meant to fit a variety of needs, from the long-term investor looking for cheap index exposure across multiple asset classes, to the closet day trader looking make a quick buck off a triple-inverse leveraged crude oil strategy, and everything in between.
What was once a simple choice of picking a passive alternative to a mutual fund has now evolved into a hot mess of products, leaving new investors (especially those who opt for the do-it-yourself approach) with an overabundance of choice.
Although Canada pioneered ETFs, the funds’ journey has been marked by frequent launches and closures, with ETFs opening and shutting down regularly throughout the years. In fact, Morningstar’s data shows that in Canada, 654 ETFs have shut their doors over the past two decades. In other words, for every four ETFs launched in Canada, one has closed.
When an ETF closes, it can happen in one of two ways: Either a merger, in which ETF unitholders are automatically transferred to a similar ETF, or a liquidation, in which the underlying assets are sold off and cash is distributed back to unitholders.
The sale of assets in the latter case constitutes a capital gain (or loss). If you happen to be holding the ETF in a non-sheltered account - outside of your registered retirement savings plan or tax-free savings account - you are liable for the taxes on the gains made. The unpredictable nature of this timing is itself a headache, not to mention the burden of finding a new place to park your cash. Unfortunately, in Canada 70 per cent of the 654 ETFs that closed in the past two decades were liquidated, not merged.
The following are distinct themes extracted from the so-called Canadian ETF “graveyard” – an analysis of the 654 ETFs that have closed over the past two decades, from 2007 to 2026, and what lessons investors can take away from them.
The small asset trap
Perhaps the most predictable finding across the closures: 80 per cent of closed ETFs had less than $10-million in assets at the time of closure. Only six funds (1 per cent) had more than $100-million. Intuitively, this makes sense. An ETF with $10-million in assets that charges a 0.50-per-cent management expense ratio generates $50,000 in annual revenue. After paying for portfolio management, compliance, custody and exchange listing fees, there’s not a whole lot left. At some point, math simply doesn’t work for the ETF issuer without siphoning support from other products.
Takeaway: Before buying any ETF, have a look at its assets under management, which should be displayed on the ETF Facts document. Small ETFs aren’t inherently bad, but in an increasingly crowded space in which they chase largely the same investor dollars, it’s possible that an ETF never reaches the minimum asset size required to stay afloat over the long term.
The low fee paradox
Morningstar has long touted the importance of keeping an eye on fund fees because they are a material detractor to investors’ long-term wealth. But how does one tell if a fund truly has low fees?
Morningstar’s Fee Level Methodology helps answer this by evaluating fund and ETF expenses within the proper context – first by investment category, and then by how the fund is sold (with a bundled advice fee, advice fee charged separately or without advice fees altogether in the case of ETFs). The methodology offers a genuinely apples-to-apples view of cost competitiveness. Once funds are placed into the appropriate peer groups, they are divided into five fee quintiles, ranging from low to high. Here’s where it gets interesting: Of the 654 ETFs that closed, 30 per cent of them (190) had a low fee at the time of closure. For fund companies, low fees mean thin margins. A low-cost ETF with mediocre asset growth is a money-losing proposition, and ETF providers aren’t charities.
Takeaway: Low fees alone won’t save you. Look for low fees plus strong asset growth and consistent trading volume.
The five-year litmus test
The closure data also reveals a stark reality about the longevity of ETFs. Of the 654 closed funds, 12 per cent closed within just two to five years (384 funds) and only 29 per cent survived beyond five years (193 funds).
This puts the average lifespan of a closed ETF in Canada at roughly 4.4 years. This data suggests that the first five years of an ETF’s life are critical. If an ETF doesn’t garner enough investor interest by year four, history tells us it is more likely than not to close.
Takeaway: New ETF launches are, statistically speaking, risky propositions. Though they might be advertised as innovative, cheaper or just interesting, there is wisdom in waiting for a fund to prove itself before investing.
Passive strategies don’t always fare better
The birth of the ETF stemmed from the core ideology that investors can’t beat the market, so why not just invest in the market? Our data shows that this is true over the long term. After fees, the majority of actively managed mutual funds fail to beat their benchmarks. What is surprising though, is that roughly half of ETFs that closed were passively managed.
In and around 2014, there was an explosion of what the market called “smart beta” ETFs (and what Morningstar refers to as strategic beta products). These products straddle the line between active and passive management by following a rules-based investment process (published in an index methodology) specifically designed to grant investors active exposure to an investment factor at a fraction of the cost of an actively managed strategy. Examples of these factors are value or growth, low volatility, dividends and so on. For investors, the benefit of these strategies is also their downfall: They grant consistent exposure to a factor without deviation. This works well when the factor is in favour (as growth stocks were during the 2010s), but not so great when markets aren’t favouring that factor (such as value stocks during the same period).
Regardless of the merit of a strategy, Morningstar’s data showed that this group of ETFs was overrepresented in the graveyard. Nineteen per cent (124 ETFs) of all closures have been strategic beta ETFs. This is a striking figure given that today, there are only 120 such products traded on Canadian exchanges.
Takeaway: Just because a fund is labeled as “passive” doesn’t mean it’s invincible. There’s plenty of competition within each fund category, so it’s smart to check how many other funds are in the same space (and likely vying for the same investors) before diving in. Smart beta strategies, while technically passive, are really an active wager on one or more investment factors – and they don’t correct course if things change. The tricky part is, it’s hard to know in advance which factors will be winners in the future.
The final takeaway
As said of many things, investing in ETFs is a marathon, not a sprint. The starting line is crowded, enthusiasm is high and everyone looks capable. But over time, the economics begin to separate ETFs built for endurance from those running on borrowed energy. ETFs don’t fail because their ideas are bad; they falter because the fuel runs out. Fixed costs keep ticking along, fee revenue doesn’t always follow and eventually even the most patient issuer has to pull a runner off the course.
For retail investors, the lesson is to focus less on who starts fast and more on who’s still moving steadily miles down the road. Scale, time and competition matter. Low fees help, but they don’t guarantee survival. Neither does a passive label or a clever twist on an index.
In a market with no shortage of shiny new entrants, there’s value in standing aside, watching the pack thin and backing the strategies that have already proven they can go the distance. In investing – as in running – longevity is rarely accidental.
This article does not constitute financial advice. Investors are urged to conduct their own independent research before buying or selling any security.
Ian Tam, CFA, is director of investment research for Morningstar Canada.