How Hedge Funds Use ETFs

March 06, 2017

Eric Balchunas is a senior ETF analyst at Bloomberg, where he has more than a decade of experience working with ETF data, designing new functions and writing ETF research for the Bloomberg terminal. He also writes articles, feature stories and blog posts on ETFs for and appears each week on Bloomberg TV and Radio to discuss ETFs. recently caught up with him to discuss how hedge funds are using ETFs. You've recently talked a lot about how hedge funds use ETFs, so I wanted to pick your brain about that. I found it interesting that you said hedge funds have more short positions than long positions in ETFs. Why is that?

Eric Balchunas: Correct; they have $104 billion in short positions compared to $30 billion in long positions.
A lot of people think hedge funds are out there trying to swing for the fences and return 100% every year. But most of them are looking to isolate certain things in the market, whether they're using merger arbitrage, event-driven or long/short strategies. To do the short side of those trades, they’ll use ETFs so they can cancel out the beta of the market and isolate their positions.

Yes, some of the shorting is just straight-up betting against the market. But most of it is this use of the ETFs as a hedging vehicle. It's interesting that the $104 billion worth of short positions is over half of the total short interest in ETFs, so it’s significant. Which ETFs are they shorting?

Balchunas: Goldman Sachs lists the short positions, and it's exactly what you would think. It's the old-school products like the Sector SPDRs, the PowerShares QQQ Trust (QQQ) and the SPDR S&P 500 ETF (SPY)―all the most liquid ones. They've also started to use the iShares iBoxx $ High Yield Corporate Bond ETF (HYG) now that it's gotten more liquid.

None of the names on the most-shorted list are surprising, but I was surprised a little by the funds that they are long. Which ones were those?

Balchunas: VWO is a good example. That's the ETF with the most net long among hedge funds.    You noted Vanguard is the only issuer where hedge funds are net long. That's an interesting pairing, because Vanguard ETFs have a reputation for being buy-and-hold types of investments, while hedge funds have a reputation for being relatively active.

Balchunas: That number is really fascinating to me and it speaks to, in my opinion, Vanguard's wide appeal. Who doesn't like cheap? That's just so universal.

Also, Vanguard may be the only one net-long, because iShares and SPDR have so many really liquid products that hedge funds love to short. On the other hand, Vanguard's products are usually the second- or third-most-liquid in a category, but rarely are they the first.

It says a little bit about the cost-consciousness of hedge funds, but it also says a little bit about how Vanguard still has yet to really break through that liquidity barrier where they become the most liquid of a category.
They're getting there. Vanguard ETFs have tripled in daily volume over the last five years. This is a big development, because if Vanguard starts to get that mass liquidity, it gets bigger fish attracted to it, and that just beefs up the liquidity exponentially.


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