Short and leveraged ETPs: the doors of opportunity

5 Jun 2014

Institutional investors have long been hampered (and oft-derided) for the oil tanker- like speed at which they reposition portfolios. Not only does this leave them open to the vagaries of the market but, once a decision to alter a portfolio allocation has been made, the fund is inherently sub-optimally positioned until the change can be transacted. For many institutional investors, that process can take several months.

Features

Interest in these products among large investors is increasing, however, particularly among UCITS funds, which cannot trade any derivatives on commodities, but can generally use ETPs to get exposure. Although they will be constrained to a maximum 10% limit in terms of the proportion of the AUM in the ETP, the increasing interest in these products creates a virtuous cycle of greater liquidity attracting greater liquidity. Some of the larger short and leveraged ETPs could comfortably allow for a $50-$80m investment without exceeding the 10% rule.

Shorting fixed income

The growing range of products offering short and leveraged exposure to fixed income markets has also attracted the attention of larger as well as smaller investors. Cumulative 12-month asset flows for short and leveraged fixed income ETPs jumped from -$500m at the start of 2013, peaking at over $5bn in February 2014 before ending March at roughly $2.5bn.

As markets prepare for yield normalisation in many markets, the ability to short fixed income has clear attractions. However, the skills necessary to execute physical short positions in fixed income and the availability of bonds to short make this difficult to execute.

Yet, the largest individual short and leveraged ETPs offer short US Treasuries (ProShares’ $4.32bn UltraShort 20+ Year Treasuries) and leveraged US equities (ProShares’ $1.7bn Ultra S&P500) exposures. Based on asset flows into ETPs offering these two exposures, Boost believes sentiment towards US fixed income has become very bearish. Average investor leverage in short and leveraged fixed income ETPs was -1.7x at the end of March (-1.8x for US government debt) with a net position of -$13.3bn.

In Europe, the largest single product is the Lyxor SGI Daily Double Short Bund with $822m of AUM. “With that AUM, there must be institutional money invested in decent sizes,” Lansing states.

The transparency, liquidity and flexibility of ETPs is naturally appealing to all investors in the bond space. As Johnson explains: “ Sourcing stock to short is much less liquid in bonds than equity and is less transparent given bonds trade over-the-counter. By virtue of the investor base, which predominantly uses these assets in asset-liability matching strategies, turnover is also less than for equities. There is something to be said for the way the ETP wrapper has altered the liquidity available to fixed income investors looking for short exposures.”