There’s been a lot of discussion about HY ETFs of late and it’s not hard to understand why.
As a reminder, junk bond funds saw massive outflows earlier this month in the wake of the market turmoil that also sent investors scurrying from IG funds (as rate jitters hit home) and, briefly, from equities.
You might recall the following from BofAML, out on February 15:
On a trailing 4 week basis, US HY has lost nearly $11bn due to redemptions, putting this episode in a league with only the 2010 EU debt crisis, the 2013 taper tantrum, and the 2014 Ukraine plane crash for the most severe outflows ever.
Citi had the following message for Bill Dudley following the “small potatoes” comment:
Citi strikes again: "New York Fed President Dudley may think the recent market losses are small potatoes but high yield listed fund outflows are more like a thick steak." pic.twitter.com/tpRTbKBdib
— Walter White (@heisenbergrpt) February 19, 2018
Whatever the case, it seems clear that investors did precisely what you might expect them to do when they started to get nervous about junk: they went to where the liquidity was, dumping HY ETFs and getting bearish via CDS.
Given all of that, you might find the following out on Tuesday from Markit interesting…
Via IHS Markit
High-yield ETFs attract record demand from short sellers
- Outflows from HY ETFs accelerate in 2018
- HY ETFs equal 26% of demand for constituent issues
- Energy most shorted sector above index weighting
Short demand for high yield ETFs is at the highest level recorded, currently over $7bn in total. Demand remains elevated despite a rally off the lows, which recovered half of the YTD losses for the products.
The ability to achieve HY short exposure via exchange listed products has allowed a wider range of market participants to put the trade on, and has contributed to rising demand for the underlying HY corporate bonds, which is also at a post-crisis high. The ETF short demand is equal to 26% of total borrow demand for the underlying issues.
Short sellers aren’t the only ones selling – the most popular high-yield ETF, HYG, has seen outflows of nearly $2.9bn so far in 2018, after seeing $1.4bn in outflows in 2017.
Demand to borrow the JNK ETF has increased sharply in 2018 as the result of a relatively lower borrow rate than HYG, however, the gap has narrowed in recent weeks. While increasing demand was the dominant factor in rising borrow costs for both issues, the inventory from agent lenders in both securities has declined 10% YTD.
A fair amount of the demand for shorts, either expressed via the ETF or the underlying issues, will be based on a general desire to have short exposure to the asset class, as opposed to expressing a negative view on specific issues. It’s a more interesting exercise then to look at the issues and sectors which have the greatest short demand beyond index weight.
At a sector level, Energy has the largest short demand beyond index weight, having less than 15% weight in the iBoxx High Yield index, while contributing 20% of constituent short demand.
The table below shows the most borrowed issues relative to index weight. It’s notable that there aren’t Energy names at the top of the individual issue list, which is the result of a more even distribution of short demand across Energy issues. Half of Energy issues are more shorted than their index weight, versus only a quarter of issues in the other sectors.
Given that there are a large number of HY issues not included in the indices, it’s worth noting that HY ETF demand is only equivalent to 15% of all HY borrows. The significance of ETFs as a source of demand is increasing, however, as they made up less than 5% of HY at the start of 2017.