Investors bet $10 billion against popular bond ETFs
The increase in such defensive trades could portend more pain for stock investors
Warning lights are flashing in a corner of U.S. debt markets.
Bond investors scrambling to protect themselves from losses are increasingly using bets against the largest junk-bond exchange-traded funds and derivatives that rise in value when corporate bonds lose ground. The popularity of such defensive trades could portend more pain for stock investors as corporate bonds, especially those with sub-investment grade, or junk, ratings, often pick up signs of economic stress before other assets.
The value of bearish bets on shares of the two largest junkbond ETFs hit a record $10 billion (U.S.) in recent weeks, according to data from IHS Markit. Downbeat wagers on indexes of credit default swaps, or CDS, for junk bonds hit a fouryear high in November, according to Citigroup.
Investors are turning to ETFs and derivatives as proxies for actual bonds because debt-trading activity, also called liquidity, has declined over the past decade as new regulations forced investment banks to pare risk-taking. Rising numbers of hedge-fund and mutualfund managers, for example, are using ETFs to quickly take bearish and bullish positions on bond markets, making them early indicators of investor sentiment.
“There’s been increased interest because people are concerned about the credit market as we get closer to the late stages of the credit cycle,” said Calvin Vinitwatanakhun, a Citigroup credit-derivatives analyst.
In derivatives markets, sellers began to outnumber buyers of the most popular CDS index tracking junk bonds in late October.
Since then, the measure of sellers to buyers has grown to its highest since 2014, data from Citigroup shows.
Short selling, or betting against, ETFs is a particularly stark example of how quickly sentiment has changed among institutional investors who until recently were chasing yield globally.
A record 59% of shares outstanding of the largest junkbond ETF have been sold short, up from about 35% in September, according to data from S&P Global Market Intelligence. Short sellers borrow securities and sell them with plans to repurchase them in the future at lower prices, pocketing the difference.
Appetite to short the ETF, operated by iShares, has far exceeded the number of shares available to borrow; ETF brokers have created an estimated $2 billion new shares to meet the demand since the start of October, said IHS Markit analyst Samuel Pierson. Short sellers of stocks and bonds are constrained by the amount of securities they can borrow. But ETF brokers can create new shares specifically to lend them out, allowing for much larger bearish positions.
Another common strategy is to buy so-called put options on junk ETFs that will pay out if the fund shares fall in value. Some of the most popular options traded on the ETF Monday targeted a 7% decline in the shares through January, according to data from Trade Alert.
At least one trader made a sizable wager that the fund would fall 12%, through June, according to Fred Ruffy, an analyst at Trade Alert. “It’s part of an ongoing bearish theme,” Mr. Ruffy said.