The Phantom ETF

World’s Largest Leveraged ETF Halts Orders, Citing “Liquidity Constraints”

 Tyler Durden on 10/14/2015

… “MF assets too large versus dealer inventories” (via Citi)… clear evidence of “structural damage in corporate bond trading liquidity” (via JP Morgan)…

Here’s how we put it last month in “How Fund Managers Use ETF Phantom Liquidity To Avert A Meltdown

In other words, if I’m a fund manager, the idea that ETFs provide liquidity rests on the assumption that when I experience outflows, someone else will be experiencing inflows and thus I can sell ETFs and avoid offloading my bonds into an illiquid corporate credit market. Put another way: I am depending on new money coming into the market to fund redemptions from previous investors who are exiting the market, all so that I can avoid liquidating assets that are declining in value and that I believe will be difficult to sell.

(But) if something were to spook the market (so that new buyers were not off-setting sellers) what would happen to prices if fund managers were suddenly forced to transact in size in an illiquid secondary market in order to meet redemptions? …

The solution is to avoid selling the underlying bonds – even when investors are selling their shares in the funds. …

In order to avoid tapping the underlying illiquid bond market in a situation where flows are unidirectional, fund managers may instead pay out redemptions in borrowed cash. …

If fund managers are forced to tap these liquidity lines (borrow cash) it likely means investors have found a reason to sell en masse and if that reason turns out to be something that permanently impairs the value of the underlying bonds (as opposed to a transitory, irrational panic) then all the funds are doing by borrowing to meet redemptions is employing leverage to stave off the recognition of losses, which is ironically the same thing (in principle anyway) that the companies whose bonds they’re holding have done to stay in business. It’s a delay-and-pray scheme designed to avoid selling the debt of companies whose similar delay-and-pray schemes have run their course. …

At the end of the day, one is reminded of what Howard Marks’ recently said about ETFs:

“[They] can’t be more liquid than the underlying and we know the underlying can be quite illiquid.”

We are about to get the real-life answer to Howard Marks’ more critical question: “What happens when ETF Holders all sell at once?”

(For background on the ETF liquidity problem, see Tic-Toc Canary)


About icliks

Biding my time in central ms ... yours too, if ur reading this.
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