Exchange Traded Funds, or ETFs, have become increasingly popular in the last few years due to their simplicity and diversity. However, not all ETFs are created equal, and some carry more risk than others. One such type of ETF that has gained attention in recent times is the Zombie ETFs. In this article, we will discuss what Zombie ETFs are, their history, risks and rewards, how to identify them, and whether you should invest in them or not.

What is a Zombie ETF and How Does it Work?

Zombie ETFs are a type of ETF that has been liquidated or is close to liquidation, but continue to trade on the exchange. These ETFs are called ‘zombies’ because they are dead but not yet removed from the market. Their value can be small, and they may be illiquid or have low trading volume, making it difficult to sell them at the desired price.

Zombie ETFs operate similarly to any other ETF, where investors can buy and sell shares of the fund through an exchange and own a share of a pool of underlying assets that track a benchmark. However, since these ETFs are zombie funds, they can be more volatile and carry a higher degree of risk.

Investors may be attracted to zombie ETFs because of their low price, which can be seen as an opportunity to buy into a fund at a discount. However, it is important to note that these ETFs may have underlying assets that are difficult to value, which can lead to inaccurate pricing and potential losses for investors.

Furthermore, since zombie ETFs are often in the process of being liquidated, investors may face unexpected tax consequences if the fund sells its underlying assets at a loss. It is important for investors to thoroughly research and understand the risks associated with investing in zombie ETFs before making any investment decisions.

The History of Zombie ETFs: From Creation to Popularity

The first Zombie ETF was launched in 2006, known as the iPath S&P 500 VIX Short-Term Futures ETN (VXX). It was designed to track the performance of the VIX index, which measures the market’s volatility. However, the fund faced significant losses, and investors lost their money, leading to the ETF’s decline in popularity. Today, there are more than 100 Zombie ETFs that trade on major exchanges across the world, and their popularity has been growing due to their high yields and potential for profits.

Despite the initial failure of the VXX, Zombie ETFs have become increasingly popular due to their unique investment strategies. These ETFs invest in distressed or bankrupt companies, with the goal of profiting from their potential recovery. This strategy can be risky, but it also offers the potential for high returns. Additionally, Zombie ETFs often have high dividend yields, making them attractive to income-seeking investors. As a result, these ETFs have gained a following among both individual and institutional investors, and their popularity shows no signs of slowing down.

The Risks and Rewards of Investing in Zombie ETFs

Zombie ETFs carry significant risks for investors due to their underlying assets’ small values and liquidity. Since these ETFs have low trading volumes, it can be challenging to sell them at a fair price, which increases the risk of losses. Additionally, these ETFs may not be well-diversified, which exposes investors to sector-specific risks.

On the other hand, investing in Zombie ETFs can yield high returns for investors if managed carefully. These ETFs may have high yields and good performance due to their underlying assets’ small values, which can lead to capital gains. Moreover, some investors take risks on Zombie ETFs due to their beaten-down value and hope to realize a profit if the ETF bounces back.

It is important to note that investing in Zombie ETFs requires a high level of expertise and knowledge. Investors must conduct thorough research on the ETF’s underlying assets, management team, and historical performance before investing. Additionally, investors must be prepared to monitor their investments closely and make quick decisions if the ETF’s value starts to decline.

Finally, investors should consider their risk tolerance and investment goals before investing in Zombie ETFs. These ETFs are not suitable for all investors and may not align with their investment objectives. Therefore, it is crucial to consult with a financial advisor before investing in Zombie ETFs.

How to Identify a Zombie ETF in Your Portfolio

It is vital to understand whether you hold any Zombie ETFs in your portfolio. You can identify them by checking the ETF’s daily trading volume, historical returns, and expense ratio. ETFs with low trading volumes, negative historical returns, and high expense ratios are more likely to be Zombie ETFs. Furthermore, you can check the ETF’s website or the security master list provider to confirm whether the ETF is active or inactive.

Another way to identify a Zombie ETF is to look at its holdings. If the ETF holds a significant amount of illiquid or hard-to-trade securities, it may be difficult for the fund to meet redemption requests from investors. This can lead to the ETF becoming inactive or even liquidating. Additionally, if the ETF’s holdings are outdated or no longer relevant to the market, it may be a sign that the fund is no longer actively managed and has become a Zombie ETF.

Why Do Some Investors Choose Zombie ETFs Over Traditional Funds?

Investors who choose Zombie ETFs over traditional funds do it for many reasons. Firstly, Zombie ETFs may have a higher yield than traditional ETFs due to their small underlying assets’ value. Secondly, some investors believe that Zombie ETFs are undervalued, and their price could spike, leading to profitable gains. Finally, investors prefer Zombie ETFs because they carry a level of risk that is higher than traditional ETFs, providing the potential for significant returns.

Another reason why some investors choose Zombie ETFs over traditional funds is that they offer exposure to niche markets or sectors that are not available in traditional ETFs. For instance, some Zombie ETFs invest in emerging markets, which are known to have high growth potential but also come with higher risks. By investing in Zombie ETFs, investors can diversify their portfolio and potentially earn higher returns.

Additionally, Zombie ETFs are known for their low expense ratios, which is another reason why some investors prefer them over traditional funds. Since Zombie ETFs are passively managed, they have lower operating costs, which translates to lower fees for investors. This makes them an attractive option for investors who are looking to minimize their investment costs and maximize their returns.

The Future of Zombie ETFs: Trends and Predictions

While the popularity of Zombie ETFs has been growing in recent years, the future trend is somewhat uncertain. Some analysts believe that these ETFs may continue to grow as investors seek high yields with manageable risks. But others predict that Zombie ETFs may struggle to survive as regulations become stricter and investors become more risk-averse.

One factor that may impact the future of Zombie ETFs is the performance of the underlying assets. As these ETFs invest in distressed or bankrupt companies, their success is heavily dependent on the ability of these companies to turn their financial situation around. If the companies fail to recover, the ETFs may suffer significant losses, leading to a decline in popularity among investors.

How to Build a Diversified Portfolio Using Zombie and Other ETFs

Zombie ETFs can play a vital role in building a diversified portfolio. However, it is essential to keep in mind that these ETFs carry a higher degree of risk and should be used carefully. To build a diversified portfolio, investors can include traditional ETFs that provide exposure to different asset classes such as stocks, bonds, and real estate investment trusts (REITs). They can also add sector-specific ETFs to capture market trends in particular industries such as technology or healthcare.

Another way to diversify a portfolio is by investing in international ETFs. These ETFs provide exposure to foreign markets and can help reduce the risk of being too heavily invested in one country’s economy. Additionally, investors can consider adding alternative ETFs such as commodities or currencies to their portfolio to further diversify their holdings.

It is important to regularly review and rebalance a diversified portfolio to ensure that it continues to align with an investor’s goals and risk tolerance. This may involve selling some holdings and adding others to maintain the desired level of diversification. By using a combination of traditional, sector-specific, international, and alternative ETFs, investors can build a well-diversified portfolio that can help them achieve their financial objectives.

Comparing the Performance of Zombie ETFs to Other Investment Vehicles

Zombie ETFs have performed better than some traditional asset classes in recent years, but they carry a higher degree of risk. Investors should compare Zombie ETFs’ performance against other alternative investments, such as mutual funds, stocks, bonds, or closed-end funds. It is vital to evaluate the risk-adjusted returns of Zombie ETFs to make an informed decision.

One factor to consider when comparing Zombie ETFs to other investment vehicles is their liquidity. Zombie ETFs may have lower trading volumes and fewer market makers, which can lead to wider bid-ask spreads and higher transaction costs. In contrast, stocks and mutual funds typically have higher liquidity, making it easier to buy and sell shares at a fair price. Investors should weigh the potential benefits of higher returns against the potential costs of lower liquidity when deciding whether to invest in Zombie ETFs.

Top 5 Best (or Worst) Performing Zombie ETFs in the Market Today

Some of the best-performing Zombie ETFs in the market today include the iPath Series B S&P 500 VIX Short-Term Futures ETN (VXXB) and the Invesco DB Commodity Index Tracking Fund (DBC). However, it is essential to keep in mind that past performance does not guarantee future returns. Therefore, investors should analyze Zombie ETFs’ performance carefully before investing.

Another Zombie ETF that has been performing well in the market is the ProShares Ultra VIX Short-Term Futures ETF (UVXY). This ETF seeks to provide investors with twice the daily performance of the S&P 500 VIX Short-Term Futures Index. However, it is important to note that this ETF is highly volatile and may not be suitable for all investors.

On the other hand, some of the worst-performing Zombie ETFs in the market today include the iPath Global Carbon ETN (GRN) and the iPath Pure Beta Broad Commodity ETN (BCM). These ETFs have experienced significant losses in recent years, and investors should carefully consider the risks before investing in them.

How to Manage Risk When Investing in Zombie ETFs

Investors can manage risk when investing in Zombie ETFs by diversifying their portfolio, setting realistic expectations, and monitoring the ETFs closely. It is important to keep in mind that Zombie ETFs carry a higher degree of risk than traditional ETFs, and the potential for losses is higher. Investors should not invest more than they can afford to lose and should consult with financial advisors before making any investment decisions.

Additionally, investors should also research the underlying assets of the Zombie ETFs they are considering investing in. Understanding the composition of the ETFs can help investors make informed decisions and better manage their risk. It is also important to keep an eye on market trends and news that may impact the performance of the ETFs. By staying informed and taking a cautious approach, investors can potentially reap the benefits of investing in Zombie ETFs while minimizing their risk.

Common Mistakes to Avoid When Investing in Zombie ETFs

Investors should avoid common mistakes when investing in Zombie ETFs. These mistakes include investing without proper research, investing without understanding the risks, and investing more money than they can afford to lose. Investors should also avoid making decisions based solely on past performance and should have an exit strategy in place to minimize losses.

Another common mistake to avoid when investing in Zombie ETFs is not diversifying your portfolio. It is important to spread your investments across different sectors and asset classes to reduce the risk of losing all your money in one investment. Additionally, investors should keep an eye on the fees associated with Zombie ETFs, as they can be higher than traditional ETFs. It is important to compare fees and choose a Zombie ETF with reasonable expenses.

Should You Invest in a Zombie ETF? Pros and Cons to Consider

The decision to invest in a Zombie ETF should depend on an investor’s risk tolerance and investment goals. While these ETFs carry a higher degree of risk, they can also provide higher yields and potential capital gains. Investors who are willing to take risks and have a high risk tolerance can consider investing in Zombie ETFs. However, investors should also be aware of the potential for losses and should invest carefully.

It is important to note that Zombie ETFs are not for everyone. These ETFs are typically focused on companies that are in financial distress or are on the verge of bankruptcy. This means that the underlying companies may have a higher likelihood of defaulting on their debt or going out of business altogether. Additionally, Zombie ETFs may have higher fees and expenses compared to other ETFs. Investors should carefully consider these factors before investing in a Zombie ETF.

The Role of Regulatory Bodies in Monitoring Zombie ETFs

Regulatory bodies play a vital role in monitoring Zombie ETFs to ensure that they follow regulations and are transparent with their investors. The Securities and Exchange Commission (SEC) in the US, for example, monitors ETFs for compliance with their regulations. Investors should also read the ETF prospectus and any other disclosure documents to understand the ETF’s objectives, strategies, and risks.

In addition to monitoring compliance with regulations, regulatory bodies also investigate and take action against any fraudulent or deceptive practices by Zombie ETFs. This includes investigating any false or misleading statements made by the ETF or its managers, as well as any insider trading or market manipulation.

Furthermore, regulatory bodies may also work with other organizations, such as stock exchanges and industry associations, to develop and implement best practices for ETFs. This can include guidelines for disclosure, risk management, and governance, which can help to improve the overall quality and transparency of Zombie ETFs and other investment products.

Understanding the Tax Implications of Investing in a Zombie ETF

Investing in a Zombie ETF may have tax implications for investors. ETFs, like any other investment, may generate capital gains or losses, which must be reported on an investor’s tax return. Investors should consult with a tax advisor to understand the tax implications of investing in a Zombie ETF.

In conclusion, Zombie ETFs are a type of ETF that has been liquidated or is close to liquidation but continues to trade on the exchange. While investing in these ETFs can yield higher returns, they carry a higher degree of risk and should be managed carefully. Investors should compare Zombie ETFs’ performance with other investment vehicles, diversify their portfolio, set realistic expectations, and monitor the ETFs closely. By doing so, investors can make informed decisions on whether to invest in a Zombie ETF or not.

It is important to note that the tax implications of investing in a Zombie ETF may vary depending on the investor’s country of residence and the tax laws in that country. For example, in some countries, capital gains from ETFs may be taxed at a lower rate than other types of investments. Therefore, investors should also consider the tax laws in their country when making investment decisions.