Will More Big Investors Use ETFs to Disguise Trades?
May 22nd 2012 at 9:26am by John Spence
A nearly $800 million trade in a junk bond exchange traded fund this month has industry analysts wondering if more large investors will tap ETFs to acquire securities while avoiding the secondary market.
“Watch to see if this idea catches on. It could become popular among well-known investors who want to move into a given market quietly,” writes Brendan Conway at Barron’s.
Earlier this month, an unidentified investor exchanged nearly 20 million shares of SPDR Barclays Capital High Yield Bond ETF (NYSEArca: JNK) for $779.3 million in bonds held by the fund, Bloomberg News reported. [Investor Uses High-Yield ETF for Camouflage]
The investor established a large position in the junk bond ETF, then redeemed the shares in exchange for the underlying high-yield bonds, rather than cash.
Knight Capital handled the trade, which it said was an example of a “customized in-kind redemption,” according to Barron’s.
The firms that make markets in ETFs and ensure their liquidity are known as “authorized participants.” Large blocks of ETF shares are created and redeemed “in-kind” based on demand, which is one reason why ETFs are tax efficient. [The ETF Creation and Redemption Process Explained]
Also, there could be a link between the JNK trade and a big transaction in PowerShares Senior Loan Portfolio (NYSEArca: BKLN). [High-Yield, Bank Loan ETF Trades Draw Attention to Debt Markets]
Michael Aneiro in a separate Barron’s post reports the big junk bond ETF trade has drawn the attention of industry analysts.
“[I]n this case, the ETF redemption mechanism was used to gain access to a significant amount of high yield bonds while avoiding the high yield secondary market altogether,” Barclays strategists said in the report. “The maneuver adds to the already-strong evidence that cash market liquidity remains challenged, as less traditional avenues for accessing liquidity in the cash market have become more attractive.”
Dow Jones Newswires reported that the investor may have tried to capture the premium or “spread” between the value of the high-yield ETF’s shares and the underlying bonds.
CreditSights analysts in the report said markets “are abuzz” with the trade and what it means for the ETF market, and other investors in such funds.
“Widely reported comments by a member of a firm that brokered the trade indicated that an investor assembled a position in the ETF with the intent of exchanging the shares for the underlying bonds as a means to implement a cash-bond portfolio,” they said.
SPDR Barclays Capital High Yield Bond ETF
The opinions and forecasts expressed herein are solely those of John Spence, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.