18% Interest Rates
Turkey's currency has been in free fall for much of 2018, direly impacting the country's economy and stock market. The cost of Turkey's foreign currency debt has spiraled to roughly half the country's GDP, while inflation is now running at 16%, increasing with every further drop in the lira.
Interest rates in the country have hit almost 18%. Even-higher rates could be possible, should Turkey's central bank lift rates in an attempt to stabilize the currency. (President Erdogan, an autocrat who runs most of Turkey's important institutions, has dissuaded Turkey's central bank from raising rates, however.)
"Right now, international investors are expressing a lack of confidence in Turkey's institutions," said Dhruv Nagrath, vice president and investment strategist for iShares' U.S. ETF Investment Strategy team (read: "ETFs With The Lowest Valuations").
TUR's trading spike, coupled with its declining returns, suggests that some portion of the fund's current inflows may be attributable to what's known as "create-to-lend" activity.
Create-to-lend is a process by which market makers create new ETF shares specifically to lend to short-sellers, who must first borrow the ETF shares before they sell (since naked-shorting is illegal). Because an ETF is an open-ended fund, market makers can make as many creation units as necessary to meet demand (read: "Is Securities Lending Good For Investors?").
In the case of TUR, short-sellers could be looking to profit from lira-driven declines in the value of Turkish stocks. Or institutions may be shorting TUR as a cheap, efficient way to hedge out Turkish equity exposure from a broader emerging market equity allocation.
"It's often quite hard to tell where primary activity is coming from, but there has been anecdotal evidence of create-to-lend activity," said Nagrath. "It's a natural consequence whenever there's a lot of short interest in a fund. It speaks to the flexibility of the [ETF] vehicle."
Of course, there are also always investors looking to buy into a perceived dip as well, he added: "This kind of volatility creates openings for opportunistic investors."
But with TUR's AUM rising 37% in less than a week, "clearly the expansion of assets is not based solely on people trying to buy the dip," said Steven Schoenfeld, founder and CIO of BlueStar Indexes, and also the co-founder of ETF.com.
Traders are also turning to TUR as an efficient mechanism for price discovery, he adds.
"When the you-know-what hits the fan, and investors need a price for a specific equity market, more often than not, the U.S.-listed ETF becomes the world's price discovery vehicle," said Schoenfeld.
The iShares Turkish ETF has become the preferred vehicle in large part because it's the only game in town. There are no index futures tied to the Turkish stock market for investors to use in its stead, and the few European Turkish equity ETFs that do exist are small, with low trading volumes.
In contrast, TUR is sizable and highly liquid, both in the primary and secondary market.
Over the past few days, "trading in TUR was entirely orderly," said Nagrath, noting that for most of Monday, TUR traded with a pennywide spread, while on Tuesday, it ranged between 0.10% and 0.15%.
Benefits Of Single-Country Funds
Similar trading spikes have arisen for similar reasons in other single-country ETFs during geopolitical crises. Earlier this year, for example, the iShares MSCI Malaysia ETF (EWM) became an essential price discovery mechanism when the country's stock market shut down for two days, following a shock election by the opposition party.
Trading in EWM spiked to 4.4 million shares in volume, more than five times its usual average daily volume.
"This speaks to the value of having single-country ETFs," said Nagrath. "There will always be that moment that comes where you'll want the right one to express a certain view."
Contact Lara Crigger at [email protected]