Short and leveraged ETPs: the doors of opportunity

5 Jun 2014

Institutional investors have long been hampered (and oft-derided) for the oil tanker- like speed at which they reposition portfolios. Not only does this leave them open to the vagaries of the market but, once a decision to alter a portfolio allocation has been made, the fund is inherently sub-optimally positioned until the change can be transacted. For many institutional investors, that process can take several months.

Features

Using short fixed income ETFs, investors can also hedge out unwanted risk on a more tactical basis. An investor holding a core position in a global bond benchmark, for example, can hedge unwanted exposure to specific markets without having to alter the core holding. Lyxor’s SGI Daily Double Short Bund, for example, has seen inflows of $174m for the year to the end of March.

Opportunity and/or threat

The tactical capabilities afforded by the liquidity, transparency, cost efficiency and flexibility of exchange traded products has been used to protect against, and exploit opportunities arising from, the impact of events on markets.

During the US Freeze in January, which saw Niagra Falls freeze over as temperatures reached -22.5C, a record last set in 1942, investors took a bullish position on Henry Hub Natural Gas prices, later taking profits and reversing the position as the Freeze thawed and the seasonal decline in demand drew investors into net short positions. Cumulative 12-month asset flows into natural gas short and leveraged ETFs ended 2013 in negative territory. During January and February cumulative 12-month flows jumped from just over -$100m at the start of the year to $400m by the end February. Average investor leverage also turned negative in early January continuing its decline to -1.2x by the end of February.

“Natural gas trading was very bullish leading into the cold snap,” says Viktor Nossek, head of resarch at Boost ETP, which is a WinsdomTree company. “That broke mid- Feb as investors redeemed long positions. At the end of March net shorts dominated. “Although the overall long-term trend for natural gas is positive, investors are taking the opportunity to take short-term tactical bearish positions in this market, which is one of the very few isolated country plays in the commodities universe,” he continues.

Path dependency

The use of short and leveraged ETPs predominantly in tactical, rather than strategic, exposures reflects one of the risks associated with these products – their path dependency.

“Although path dependency can be easily managed,” argues Deutsche Asset & Wealth Management’s head of ETP product development, EMEA, Arne Noack, “it needs to be taken into account. People can easily forget that being short bond or equity markets means being short carry and investors need to pay out to cover coupons or the borrowing costs on a running basis.”