New ETFs Struggle to Get Off the Ground

One of the big benefits of exchange-traded funds is their liquidity: Unlike open-end mutual funds, which can only be bought and sold once a day, these baskets of securities trade throughout the day on an exchange.

But what happens if you can't unload the shares when you need to? With so many new products competing for the attention of "specialists" who make a market in ETFs, there's a risk that trading will be illiquid.

This was a major theme at an industry gathering in New York last week. Participants at Financial Research Associates' ETF Summit lamented that it's becoming increasingly difficult to raise the money necessary to launch new products, and that this could slow the industry's pace of growth.

"The seed capital the industry has relied upon has run dry just as there are a plethora of products coming to the market," said Agustin Fleites, a former executive at State Street Global Advisors and ProShares.

One-quarter of the 516 ETFs currently available in the U.S. have been launched in the last six months, according to Lipper.

ETF sponsors rely on the same specialists who maintain an orderly market in stocks to ensure that funds' share prices don't move out of line with the value of their holdings. Specialists do this by creating new shares when demand outstrips supply and dissolving ETF shares into their constituent securities when supply exceeds demand. They create these new shares in blocks of 50,000.

Currently, specialists are expected to provide the start-up funds necessary to assemble the number of ETF shares needed on the first day of trading -- typically 100,000. But with so many new products hitting the market, ETF sponsors may have to start coming up with their own "seed" capital, participants at last week's conference said.