Why are short positions in high-yield bond funds increasing?
On February 28, 2014, the short interest on high-yield bond ETFs HYG and JNK had increased to ~21% and 10%, respectively, of the total shares outstanding.
What are short interest and the short-interest ratio?
Short interest is the number of shares of a security that have been sold short by short sellers, who expect to profit from a fall in the price of the security. The short interest ratio (or SIR) for an ETF is the number of shares of the ETF that are sold short divided by the average daily trading volume, computed over the past 30 days. The ratio represents the average number of days required to enable short sellers to purchase the shares sold short or borrowed.
How do short interest ratios signal market sentiment?
Increasing short-interest ratios are usually a bearish signal, as short sellers believe the price of the ETF is going down. In order to profit from their bearish expectations, short sellers borrow shares to sell them at the prevailing high prices. If the price of the shares falls below their selling price, they make a profit when they purchase them at a lower price to replace the shares they had borrowed earlier. However, if the share price increases over their selling price, short sellers end up taking a loss, as they have to purchase the shares at a higher cost.
The purpose of this series is to observe and analyze short-interest ratios from 2009 to February 2014 for high-yield fixed income ETFs and compare them to the short interest ratio for the S&P 500 Index (SPY). High-yield bonds are defined as bonds rated non-investment grade by credit rating agencies—Below Baa by Moody’s or Below BBB- by S&P and Fitch.
For the purpose of this series, we’ll consider two major ETFs that invest in high-yield bonds:
- The SPDR Barclays Capital High Yield Bond ETF (JNK) tracks the Barclays Capital High Yield Very Liquid Index. The index includes publicly issued non–investment grade fixed-rate taxable corporate bonds with a maturity in excess of one year, with $600 million or more of outstanding face value. Top holdings in JNK include Sprint 144A 7.875% (S), with 0.62% of assets. JNK has an expense ratio of 0.4%.
- The iShares iBoxx $ High Yield Corporate Bond ETF (HYG) tracks the iBoxx $ Liquid High Yield Index. The index is rules-based and provides a broad representation of the U.S. dollar–denominated liquid high-yield corporate bond market. With an expense ratio of 0.5%, top holdings in HYG include Sallie Mae 8.45% (SLM), with 0.39% of total assets.
We’ll also compare the short interest for high-yield bond ETFs with the S&P 500 Index, since price movements on high-yield bonds have a greater correlation to price movements with stocks rather than other fixed-income securities. The State Street SPDR S&P 500 ETF (SPY) tracks the S&P 500 Index. The short interest ratio for SPY stood at 2.1x on February 28, 2014. This was slightly higher than the average short interest ratio for 2013 at 2.05x. iPhone and iPad maker Apple (AAPL), at 4.85% of fund assets, is the largest holding in the ETF. Besides high-end mobiles and tablets, Apple (AAPL) may soon enter into the TV streaming business to bypass web traffic congestion.
To learn more about why short interest figures contradict past trends, read on to Part 2 of this series.