Behind Turkey ETF's Mega Volume

August 16, 2018

As the Turkish economy hit its crisis point this past week, traders piled en-masse into the $386 million iShares MSCI Turkey ETF (TUR).

Beyond the flashpoint headlines, the fund has emerged as the go-to vehicle for institutional hedging, short-selling profiteering and even price discovery. The wave of inflows speaks to how investors are using the ETF structure to fill a trading void as much as "buy the dip."

This past Friday, Aug. 10, TUR saw its highest amount of daily trading volume ever, with 13.3 million shares exchanging hands. That's an eye-popping amount for a fund that usually trades closer to 500,000 shares daily.

Then on Monday, TUR had another outsized trading day, with 12.6 million shares traded. Though volume had begun to slow by Tuesday, down to 5.3 million shares traded, volume still remains well above historical norms:

 

Sources: ETF.com, FactSet; data as of Aug. 15, 2018

 

According to issuer data, $272 million worth of TUR shares changed hands on Friday—a sum 17 times the usual average daily volume and worth nearly the entire assets under management (AUM) in the fund that day.

Wave Of Flows

All this trading activity has translated into significant new net inflows into TUR relative to the size of fund, which, as of a week ago, had $281 million in AUM.

On Friday, TUR saw net inflows of $18 million, followed by $53 million on Monday. On Tuesday, investors plowed $90 million into the fund, bringing the grand total to $161 million—or 82% of TUR's year-to-date inflows of $197 million.

 

Sources: ETF.com, FactSet; data as of Aug. 15, 2018

 

At the same time, however, TUR's performance has plummeted. As of Wednesday, Aug. 15, TUR was down a whopping 49% year-to-date (read: "Worst Performing Single Country ETFs").

 

Source: StockCharts.com  data as of Aug. 15, 2018

 

Turkey In Crisis

TUR's trading spike is a direct result of Turkey's economic troubles, which hit a boiling point on Friday following President Trump's announcement that he planned to double tariffs levied on U.S. imports of Turkish steel and aluminum. The move was in retaliation for Turkey refusing to release Andrew Brunson, an American political prisoner held in Izmir.

On Friday and Monday, the lira, Turkey's currency, dropped more than 25%, striking a record low. It has since rebounded several percentage points, due to new tariffs President Erdogan placed on Turkish imports of U.S. alcohol, automobiles and tobacco announced Wednesday morning.

How long the lira's rebound lasts, however, is anybody's guess.

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").

Create-To-Lend?

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.

Price Discovery

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.

Spikes have arisen in the iShares MSCI Brazil ETF (EWZ) earlier this year, when the Brazil real fell; and in the Global X MSCI Greece ETF (GREK) during the Greek financial crisis.

"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]

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