High-Yield ETFs: Credit Traders Help Drive Record Short Interest

Includes: HYG, JNK
by: Tom Lydon

By John Spence & Tom Lydon

Bearish bets against high-yield bond ETFs hit record levels this month and the activity appears to be partly driven by Wall Street credit brokers who are offering large trades to clients.

The iShares iBoxx High Yield Corporate Bond (NYSEARCA:HYG) and SPDR Barclays Capital High Yield Bond (NYSEARCA:JNK) are the largest junk debt ETFs.

Bloomberg News reports that Bank of America (NYSE:BAC) traders who helped dealers move $1.5 trillion of credit-default swaps index contracts in 2012 began offering clients the ability to trade blocks of HYG last month.

"As the high-yield ETF market has grown, we've seen institutional investors using high-yield ETFs to build portfolios and manage risk," said Matthew Tucker, head of iShares fixed-income strategy for BlackRock, which manages HYG. "They've been looking for ways to both go long the high-yield market and hedge against losses."

Shares on loan from both HYG and JNK were above 10% this month, according to the report. ETFs can be shorted like individual stocks. Investors borrow shares of the ETF and sell it to another party, hoping the price declines and they can buy it back, return the shares to the original owner, and pocket the difference. Investors short ETFs to hedge long positions or speculate on market weakness.

The number of borrowed shares in HYG and JNK almost doubled last month, Bloomberg reports.

"To the extent that investors want to hedge both their credit risk and their interest-rate risk, selling the ETFs can make sense," said Eric Gross, a credit strategist at Barclays, in the article.

Junk bond ETFs are trying to break out to their highest price levels since the financial crisis with yields in speculative-grade corporate debt falling to record lows. Investors have been taking on more credit risk in junk bonds in search of yield with the Federal Reserve keeping short-term rates near zero.

A Bank of America trader offered trades of about $30 million in HYG, in an e-mail listing securities available for sale to clients last month, Bloomberg reported. This credit-swaps index trader also offered trades in about $20 million of shares from JNK. February was the first time that Bank of America's swaps traders started trading blocks of ETF shares.

"High-yield ETFs tend to be more volatile than the underlying broad market," said Jason Rosiak, head of portfolio management at Pacific Asset Management, in the Bloomberg story. "It's a new tool due to their size and liquidity."

"We've seen increasing availability of ETF shares for borrowing and selling short as a hedging vehicle," BlackRock's Tucker added.

iShares iBoxx High Yield Corporate Bond

Full disclosure: Tom Lydon's clients own HYG and JNK.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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