Investors and portfolio managers who turned to derivative products, such as options and swaps, to try and hedge their long exposure have been shocked to see premiums explode as delta and gamma volatility surged. Many of these investors and portfolio managers turned to the ETF market in order to create hedges and Alpha plays in this volatile market. Unfortunately, as we were able to see in our S3 Black App screening tool, the cost to short ETFs has also increased significantly.
While the cost of short selling in the equity market has only increased slightly in March, with the average stock borrow fee on the $678 billion of equity shares shorted increasing by only three basis points, from an average of 62bps to 65 bps, the cost of shorting ETFs has risen dramatically. The average cost to borrow for the $147 billion of ETF shorts was 75 bps on March 1st, and as of March 18th it has risen 40% to 105 bps.
ETF short sellers, who were paying $3.1 million per day in stock borrow expenses on March 1st are now paying $4.3 million day. This increase would amount to yearly ETF stock borrowing costs increasing from $1.11 billion/year to $1.55 billion/year, an increase of $443 million/year, a noticeable hit to an investor’s or portfolio manager’s bottom line.
The list of the most shorted ETFs is led by hedging names. SPY, QQQ, IWM and EEM have been the primary ETF hedging vehicles historically, but over the past year we have seen a greater dispersion of hedging activities into the Fixed Income based ETFs such as HYG, LQD and TLT. Recently, the spectrum of hedging related ETF activity has grown even more, with health and volatility related ETFs such as XBI, XLV, IBB, VXX and TVIX comfortably in the top twenty.
ETFs with the largest Short Interest:
While there are no ETFs with sky high stock borrow rates, such as SmileDirectClub (SDC) at 75% fee, there are several with rates over 10% fee. The two reasons why ETFs stock borrow rates rarely get too expensive is that ETF’s can be “created to lend” by brokers if spreads are wide enough and the fact that there are a large amount of long ETF positions in rehypothecatable accounts which are lent to the street by brokers to earn incremental fees.
ETFs with the highest Stock Borrow Fees:
Stock borrow rates have gone up even for even the most vanilla ETFs with rates of the big three (SPY, QQQ and IWM) moving up from their usual General Collateral fee levels of 0.30% fee. The ETFs with the largest increases in stock borrow fees are a mixed bag of sectors but there is a preponderance of Fixed Income leveraged ETFs in the top twenty.
ETFs with largest increase in Stock Borrow Fees in March:
Overall, ETF stock borrow costs have increased from $3.1 million/day to $4.3 million/day. The ETFs with the largest daily stock borrow costs are a mix of the most shorted ETFs and the most expensive to borrow.
ETFs with highest Daily Stock Borrow Costs:
A small change in stock borrow fees can have a large effect on total cost for a highly shorted ETF. Total stock loan expense for the SPY ETF has more than doubled as its stock borrow rate rose to 0.65% fee. Once again, Fixed Income ETFs are predominant in the top ten.
ETFs with largest increase in Daily Stock Borrow Costs:
We expect ETF stock borrow rates to continue to climb as long ETF holders continue to liquidate their positions and therefore decreasing lendable rehypothecatable supply. The cost of portfolio hedging will continue to increase and there will be scarcity of stock borrow supply in certain ETFs, primarily leveraged and niche ETFs, which are more difficult and expensive to create, hedge and lend out to the street.
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Managing Director Predictive Analytics, S3 Partners, LLC
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