Those ETF shorts

Blackrock, the world’s largest asset manager — with $3,450bn under management according to figures released on Wednesday — puts out a regular quarterly review of the ETF industry.
And as usual, it presents some interesting factoids on all matters exchange-traded fund — be they product, currency or commodity. Blackrock itself, of course, is a leading player in the ETF market through its ownership of iShares and currently — according to its own report — has some $534.6bn in ETF assets under management.

Amongst other things there are some good statistics on just how shorted ETFs are, which is interesting given some of the debate that’s focused on the matter recently.
We stress the ETF industry maintains that the creation/redemption mechanisms built into the structures — designed to keep the funds tracking their underlying benchmarks — would prevent any possible shorting-related implosion.

Nevertheless, it is interesting to what degree these products are now being used in this manner, since it reflects just how actively and dynamically they are being traded.
As Blackrock’s Deborah Fuhr, author of the report, notes:

Short interest in United States listed ETFs have reached the highest ever during 2010.
• Based on data through September 2010 the average number of ETF shares short during 2010 YTD reached an all time high of 1,735 Mn shares, with an average of 1,653 Mn in 2009 and 1,693 Mn in 2008. The September 2010 short interest level for United Stateslisted ETFs was 11.1% of shares outstanding or 1,811 Mn shares, up 4.4% from 1,735 Mn in December 2009. Investors are using ETFs for long/short and hedging strategies.

All of which means, if you happen to be long ETFs, you can now make quite a healthy return from just lending them out — in many cases making up for the management/expense fees incurred by owning them.
As Fuhr explains:

For investors who own ETF shares, the lending revenue that can be earned on ETFs, may at times, and for some ETFs, more than cover the annual Total Expense Ratio (TER). Short interest is often considered an indication of the level of scepticism in the market.

Of course, short interest should be considered in view of outstanding shares — and here the latest figures suggest a more muted trend in historic terms. For example, in September, some 11.2 per cent of all US ETF shares were currently out on loan, which compares to an average of 12.4 per cent in 2009, 17 per cent in 2008 and 16.1 per cent in 2007.

Of course, some ETFs do remain more shorted than others. A number even have more stock out on loan than outstanding shares.

Here, for example, is the latest chart from Blackrock showing the top 20 US ETFs based on short interest — with those ratios over 100 per cent relative to outstanding shares highlighted by us:

According to Fuhr, though, it shouldn’t signal anything alarming if an ETF does have more than 100 per cent of its shares out on loan. The situation, she says, is simply the result of the same shares simply being lent onwards and onwards.

If you actually went to redeem the shares, you would have to own them first, she stresses.
Meanwhile, if the process of acquiring them generated a squeeze, authorised participants would be triggered into action — rebalancing the market as they came in.

Of course, we’re not sure how that fits with the picture of regular and consecutive ETF settlement fails, as depicted in Threshold Security data from the NYSE Arca exchange. The numbers here may simply be too small to count.

Meanwhile, as an aside, the report also notes that in September 2010 US ETF turnover made up 25.9 per cent of total BlackRock equity revenue, with the average daily trading volume year-to-date up by some 15.5 per cent to $52.9bn.
Full ETF market report in the usual place.