No Need To Worry, Hidden Plumbing Keeps You Safe From An ETF Collapse (XRT)

Andrew Bogan of Bogan Associates, released a report last week detailing how people selling short shares could potentially cause the collapse of an ETF. The major focus of this report was the SPDR S&P Retail ETF (NYSE: XRT). Boy did that report, and the subsequent segment aired on CNBC, create quite the hub bub throughout the ETF industry. Experts from all corners of the field say no way Jose. Reading between the lines, it is not impossible, just not probable.

In the Bogan report, they state that, “While an ETF owner believes their ETF shares represent ownership of the underlying shares of stock in the index that the ETF tracks, that stock is not always all there. Because of explosive short interest in some ETFs, owners of ETF shares often far outnumber the actual ownership of the underlying index equities by the ETF operator. One might ask how that can be possible, but the creation and redemption mechanisms inherent to ETFs mean that short sellers need not be concerned about the availability of shares outstanding when they sell an ETF short—since they can always create new shares using creation units to cover short positions in ETFs in the future. In essence, there appears to be little risk to being short an ETF since the short seller can always “create to cover”. This has led to some ETFs having shockingly large short interest as compared to their number of shares outstanding and for every additional ETF share sold short, there is another owner of that share.”

Bradly Kay of Morningstar addresses this issue in a recent video (below). Kay states, “Exactly, is there a chance that you bought shares off the exchange and they happen to be, say, phantom shares produced by a short seller. But in reality thankfully that isn’t the case. What tends to happen, if you are trying to short shares, you have to borrow them first, and so that is really the key to this entire issue. If you go and sell shares without having borrowed them first, three days later you are up the creek, because you do not actually have any shares that you can deliver–three days being the settlement period for equities and ETFs. What you instead do is you go into the institutional borrowing market. You find an institution who is already holding those shares or is willing to buy those shares and hold them for you, and then that gets lent to you who want to short the shares. In turn you provide collateral that is worth just as much as the shares you’re borrowing.”

See the Morningstar video below, as well as some other good video and read’s on the topic:

Can An Etf Collapse No

Why An Etf Can’t Collapse

Leave a Reply

Your email address will not be published. Required fields are marked *