shares from time to time,15 the tighter the market spread and, other things
being equal, the more active trading in the fund shares becomes, the easier
and cheaper it will be to trade shares in the fund. However, significant
effects of a fund’s membership in an index arbitrage complex and trading
in different market centers competing to tighten trading spreads are still
confined to two funds: the S&P 500 SPDRs and the QQQs. Shareholders
in funds with at least $100 million in assets and a conscientious exchange
specialist are not likely to be at a significant trading cost disadvantage to
multibillion dollar funds with more trading activity, but no active futures
contract. Trading has to expand very dramatically before trading activity
per se has a significant effect on ETF trading costs.
Great popularity in the market for risk management instruments is
not necessarily an advantage to an ETF’s investment advisor. ETF short
sales supported by market-maker-share inventories held to lend to short
sellers have a positive effect on an ETF’s shares outstanding. These market
maker activities, in fact, foster the creation of lendable fund shares
that pay fees to the fund advisor, increasing the assets under management
and, together with the increase in trading activity, create an appearance
of success for the fund that might have the effect of attracting additional
assets. On the other hand, if the recent trend to less-covered lending by
specialists and other market makers, who create shares to lend them, and
more lending by other holders of ETFs becomes the dominant pattern,
short selling will reduce an ETF’s shares outstanding. A short seller needs
a buyer. If shares are easy to borrow, that buyer is likely to be a market
maker who will sell the shares back to the fund and shares outstanding
will decline. It matters very much to fund advisors whether shares are
created to lend or lending is an incidental activity of ETF investors and
replaces shares issued by the fund.
To put the impact of short selling ETFs in an economic perspective, if
all open short positions in the QQQs in December 2003 were covered by
share borrowing from traditional investors, the shares supplied by the
short sellers reduced the fund’s assets by approximately $12.5 billion. At
the fund’s 20 basis point expense ratio, this represents forgone fee revenue
of approximately $25 million annualized. There is little question that
the large benchmark ETFs are more actively traded as a result of risk
management applications. Short sellers can meet the needs of ETF buyers
with shares borrowed from traditional investors rather than shares created
to be loaned. This pattern is certainly not attractive to the fund’s
advisor. Of course, without the effect of active trading, the funds might be
much smaller, making the net effect of a large-short interest unclear.
Read More : Are Risk Management Applications And Heavy ETF Share Trading Desirable For Fund Shareholder And Fund Advisors?
