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• Nadig On CNBC: ETF Fears Overblown
• Can An ETF Collapse? No

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Fears that leveraged ETFs are causing end-of-day volatility or posing risks to the entire financial system are overblown, IndexUniverse Research Director Dave Nadig said in a CNBC appearance on the same day a Senate committee met to discuss those very questions.

Nadig also said that to the extent such securities aren’t appropriate for many in the market, requiring retail investors to gain special privilege to trade inverse and leveraged ETFs was an idea that was probably worth exploring.

“I think it’s rational to talk about whether or not there should be the same kinds of protections in place where investors, for instance, can’t open a margin account without having some kind of additional disclosure,” Nadig said in his TV appearance.

“But some of this discussion about [leveraged ETFs] somehow endangering the global financial system is a little overblown,” Nadig said.

“These products, in total, have about $36 billion in them. That may seem like a lot of money to you and me, but in the grand scheme of the $56 trillion global equity market, $36 billion is kind of nothing.”

Leveraged and inverse ETFs were at the center of the Senate hearing this week, with panelist Harold Bradley, the chief investment officer of the Kauffman Foundation, saying they were surely to blame for most of the volatility in financial markets since early August when S'P downgraded U.S. debt. Bradley also said the heavy trading of some ETFs could pose risks to the financial system.

“Price volatility is scaring individual investors. It is not an accident that mutual funds have seen such large net redemptions,” Bradley said in his Senate testimony. “These investors are either going into ETFs, and thus perhaps unknowingly contributing to market volatility in the process, or out of the markets altogether in cash.”

The Volatility Issue

In his CNBC appearance on Oct. 19, Nadig cited original IndexUniverse research that failed to show any link between end-of-day volatility and ETFs.

“The issue of volatility is always a tough one—everyone always wants to point a finger,” Nadig said. “We just did a big study on inverse and leverage trading at the end of the day, and we found pretty conclusively that there’s no way to say this end-of-day trading is driving the market one way or another.

“At the end of the day—between 3 and 4 o’clock—the market is 50-50 to go up or down from where it already was that day. The volatility we’re seeing is not happening on end-of-day trading—it just isn’t happening. The data just don’t back that up.”

Andrew Bogan As Foil

Nadig appeared on the CNBC segment program with Andrew Bogan, a managing member of Boston-based money manager and research firm Bogan Associates.

Bogan Associates made headlines about a year ago when it published a white paper arguing that heavily shorted ETFs could collapse if suddenly all the shares short were called in for redemption.

Bogan, in his CNBC appearance, reiterated some of the concerns he raised in the paper he co-authored in September 2010 titled “Can An ETF Collapse?”

“I think there really is potential for systemic risk from ETFs, particularly in the form of heavy short selling, not just leveraged ETFs,” Bogan said on CNBC. “There’s a lot of serial shorting of those products, which is a complicating factor, and creates some pretty serious counterparty risk.”

Nadig didn’t get the opportunity on CNBC to comment on the risks related to heavily shorted ETFs.

But IndexUniverse’s Global Head of Editorial and President of ETF Analytics Matt Hougan challenged the so-called Bogan Report in a blog last year titled “Can An ETF Collapse? No”

In his riposte, Hougan noted Bogan was hardly the first to consider the mechanics of heavily shorted ETFs, and stressed that fund sponsors won’t redeem share that holders don’t have full legal right to and that have been loaned out or are otherwise unavailable to the trust at the time of redemption.

In other words, the scenario Bogan Associates envisaged isn’t really possible.

Hougan was citing plainly viewable information in the prospectus and Statement of Additional Information ( SAI ) on the SPDR S'P Retail ETF (NYSEArca:XRT), surely the poster child of heavily shorted U.S.-listed ETFs.

In our most recent “Short Report,” the number of XRT shares short was more than five times the outstanding number of XRT shares long at the end of September.

While short interest data are difficult to capture with perfect accuracy, it’s safe to say that such elevated short interest is a reflection of XRT shares being loaned, and then re-loaned numerous times, with each discrete loan transaction added to the short-interest total.

Don't forget to check IndexUniverse.com's ETF Data section.

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