The short selling strategy has attracted a lot of attention over the past two weeks as investors quickly bought into GameStop shares, which would give an epic short press. But while a troubled company like GameStop or AMC Theaters may seem like the obvious target, there is an even more enticing target: exchange-traded funds.
Following the ETF leaders
The SPDR S&P Biotech ETF is an industry-specific index fund with shares among biotechnology companies. Despite a one-year return of more than 83%, the SPDR Biotech ETF has a short-term interest rate of 102% on February 1, one of the highest bonds traded on all exchanges. (An ETF may have a short-term interest rate of more than 100% if the number of abbreviated shares is much higher than the number of shares issued. This is usually an indication of the leverage of the hedge fund.) The short interest in the ETF dropped to 98%. today. By comparison, the short-term stake in Gamestop on January 27 was 88.6%.
“Some people really put their money where their mouth is, to express their prediction,” said Lisa Kramer, a professor of finance at the University of Toronto.
ETFs: Less risky for design
An ETF is a specific type of index fund that tracks a number of underlying investments in a particular industry or market segment. ETFs allow small and institutional investors to hold pieces of multiple investments simultaneously instead of concentrating on a specific company or one type of asset such as gold, allowing investors to diversify and reduce their financial risk. ETFs have predetermined rules; they trade in public wallets throughout the day; they are often run by large financial companies such as Fidelity, BlackRock and Vanguard; and they are popular because of their low cost, greater flexibility and tax advantages compared to mutual funds. The ETF industry grew to more than $ 5 billion during the pandemic, fueled by $ 400 billion in new investment, low Federal Reserve interest rates and investors’ optimism about an economic recovery later this year.
According to experts, buying a short index ETFs is a way for traders to reduce the risk in an investment portfolio. “It gives someone an easy way to hedge or diversify industry-specific risks,” says Nikolai Roussanov, a professor of finance at the University of Pennsylvania’s Wharton School of Management.
Greater than the sum of the expenses
Short-term interest in an ETF can rise above 100% because an issued ETF share can be borrowed and borrowed more than once. Each time this process takes place, it increases the so-called ‘long and short exposure’, but it does not increase the number of outstanding shares. Shorting is often done by hedge funds that want to hedge an existing bet that another stake in their portfolio will increase in value.
Roussanov said it should come as no surprise that there are, on average, more shortages of ETFs compared to individual stocks due to the creation and redemption process.
Large financial institutions, known as authorized participants, can request the creation of new ETF shares and also redeem ETF shares for the underlying securities. When the value of an ETF is higher or lower than the underlying securities, an AP can intervene by making transactions that bring the price of the ETF back to its fair value. These processes can cause changes in the number of short positions and outstanding stocks fairly quickly and in both directions on a daily basis.
“The size of the fund goes up and down because it adapts relatively easily to the buying and selling pressures like the number of outstanding shares for an individual company would not be able to do,” Roussanov said.
The impact of Gamestop
One ETF in particular has seen wild gains over the past two weeks. Short-term interest in the SPDR S&P Retail ETF rose above 600% on January 27, mainly because it owned GameStop.
The retail ETF is equal in weight, meaning that each of its 95 stocks usually does not exceed 1.6% of its total assets under management. That changed when the price of Gamestop soared to more than $ 460 on January 28, raising the company’s weight in the fund to 20%. According to Bloomberg Intelligence, there was suddenly a huge demand for the ETF’s retail holdings due to GameStop’s momentum. This led to an increase in trading and an outflow of more than $ 506 million on January 28, after APs redeemed shares of the ETF. This redemption helped increase the number of Gamestop shares in circulation, but also tapped most of the ETF’s assets.
Not for beginners
Experts believe that the ‘extreme agility and discipline’ needed to manage short selling means that the high level of short-term interest in these ETFs comes primarily from hedge funds and private equity funds, not from new retail investors who have recently poured into apps like Robinhood do not have. Since short selling is primarily a momentum and short-term trading strategy, it is different from ordinary investing, which is more about holding bonds for a longer term.
Sara Walker, a senior strategist at BMO Wealth Management, considers the sales of such a speculative strategy that she tells her clients that it should only be done with ‘crazy money’, a specific pool of funds that someone can afford to get away with. to gamble. “Just remember: there is a limit on the upside, which means a limit on the money you can earn, but no limit on the money you can lose.”