Investors Hit A Snag Shorting ETFs
06/17/2004
Dow Jones News Services
(Copyright © 2004 Dow Jones & Company, Inc.)
By Tara Siegel Bernard
A Dow Jones Newswires Column
NEW YORK (Dow Jones)--Exchange-traded funds, or ETFs, are often touted as an easy way to sell a basket of stocks short. But many retail investors have recently learned that they're too small to participate in the game.
ETFs are essentially a collection of securities that track an index. However, unlike traditional mutual funds, they trade on exchanges and price throughout the day like stocks. They're often praised for their tax efficiency, low costs, transparency and diversification.
They also have another benefit: securities law prevents selling a stock short unless its last trade was up in price, known as the "uptick rule." However, the same does not go for ETFs, so ETF short sellers don't have to wait for an uptick.
However, smaller investors have been having trouble shorting at all - particularly in ETFs that track a single sector or country.
"Being able to short anything is always a function of available stock," said Dave Fry, founder and publisher of ETF Digest, which offers investors trading strategies using exchange-traded funds. "And what they are saying is that there is no stock available for shorting."
Fry said many of his subscribers have recently reported having trouble with the iShares Trust Lehman 20-Year Treasury Bond (TLT), iShares MSCI Taiwan Index Fund (EWT), and the iShares Inc. MSCI Emerging Markets Index Fund (EEM).
"There should never be a problem if you want to sell an ETF short, in borrowing the stock, as long as you are trading in adequate amounts," added Gary Gastineau, principal of ETF Consultants LLC. "But if you are trying to sell 1,000 shares, you are not even on the radar screen of their stock-loan desks."
Indeed, one ETF trader, who has also heard of the recent shorting bottleneck, said that he believes that if a stock-loan department doesn't have a lot of shares on hand, they may just tell customers they don't have them given the costs involved to get them or create them - and some may simply be lazy.
"If they don't have it internally, they should be making phone calls," the trader said. "We want all customers to be able to borrow the securities because if they don't they dismiss the product."
Barclays Global Investors, which offers ETFs under the iShares brand, acknowledged that some small investors have had trouble shorting, notably within sector ETFs. BGI spokesman, Tom Taggart, said that institutions who are market-makers typically create ETFs in "creation units" of 50,000 shares or more. "So if an investor is trying to short 1,000 shares of an ETF, depending on the broker-dealer and how big of a client they are with their broker-dealer, they might not get it done. This is an issue across the industry, not just with iShares."
A stock-loan desk executive echoed those sentiments: he said many of the smaller ETFs do not have large enough floats, and there isn't enough demand for institutions to create more shares.
It's easy to see why many investors have been trying to short TLT, or the iShares Trust Lehman 20-Year Treasury Bond, which tracks the eponymous Lehman index, which represents the long end of the Treasury market. When interest rates go up - which is obviously widely anticipated - the price of bonds goes down. So when investors short TLT, they are selling borrowed shares in hopes of returning them at a lower price and pocketing the difference. TLT has a short interest of 180% and there are 7 million shares outstanding, according to ETF Consultants.
But again, smaller orders create a problem: bond ETFs must be created in 100,000 share units, the stock-loan executive said, so that essentially squeezes the little guy out.
"They (brokerage firms) are not in the business of holding large amounts of these things on their books just to create liquidity," said Michael E. Kitces, director of financial planning at the Pinnacle Advisory Group in Columbia, Md. "Interest rates can move and they could end up holding shares they did not want to hold."
However, plenty of institutional investors, like hedge funds, and broker dealers, are using ETFs to short: At the end of May, the Standard & Poor's Depository Receipts SPDR (SPY) had a 23.6% short interest position, while the Nasdaq-100 Index Tracking Stock (QQQ) had a 47.8% short interest position, and the iShares Russell 2000 Index Fund (IWM) had a 85.5% short position, according to ETF Consultants.
Barclays' Taggart said that smaller investors shouldn't have trouble in the larger broad-based market ETFs, and said investors "will see the ability to short more products more efficiently down the road. We are seeing real improvement as more people get into the lending game."
(Tara Siegel Bernard is one of four Getting Personal columnists who write about personal-finance issues ranging from new tax proposals to education-funding strategies to estate planning.)
-By Tara Siegel Bernard, Dow Jones Newswires
