BlackRock Inc. is seeking regulatory clearance to create exchange-traded funds that can bet against stocks or bonds, as the $826 billion industry’s largest player seeks new products to boost revenue.
The company applied today with the U.S. Securities and Exchange Commission for the right to engage in short sales when running ETFs that track market indexes. Until now, the New York- based company’s ETFs have been based on indexes that buy stocks rather than selling them short, a strategy that generates profits when the underlying asset declines in value.
Firms like BlackRock are exhausting the market for ETFs that track traditional benchmarks, such as the Standard & Poor’s 500 Index, said Peter Shea, a lawyer in the New York office of Katten Muchin Rosenman LLP. The ability to engage in short sales would help such firms expand into other areas once dominated by money managers using active strategies, he said.
“Sponsors of ETFs are cognizant that their growth has come at the expense of managed mutual funds,” said Shea, who works with ETFs and exchange traded commodity products. “To lock in that growth, there is a movement towards diversifying their products into strategy-based ETFs.”
ETFs were originally designed to invest passively in baskets of securities designed to mirror the performance of indexes and commodities such as gold. Unlike index mutual funds, which are priced at the end of the day, the value of ETFs changes as they trade throughout the day.
Since their introduction in 1993, ETFs have taken almost half of the $1.75 trillion market for so-called passive products that mimic a stock or bond index. PowerShares Capital Management LLC, the ETF unit of Invesco Ltd., received SEC approval in 2008 for the first actively managed ETFs, which also were viewed as having the potential to undercut mutual funds.
BlackRock became the largest U.S. provider of ETFs through its December acquisition of Barclays Global Investors for $15.2 billion. Its IShares brand of ETFs oversees about $395 billion, equaling a 48 percent market share, said Christine Hudacko, a BlackRock spokeswoman in San Francisco.
According to the application filed today, BlackRock will offer ETFs based on indexes that invest in some assets, known as long positions, and sell others to create short positions. The firm may later create funds that are based on indexes that exclusively hold short positions, the filing said.
“We may offer long-short strategies in any number of ways, one being we would track an index,” Hudacko said in an interview today. “We may also do it in other ways, such as more active-type strategies.”
Selling short is the practice of borrowing securities and selling them in the hope that their price will decrease. A short seller profits by buying back the asset at a lower price and pocketing the difference.
ProShare Advisors LLC announced in July 2009 that it would open the nation’s first 130/30 ETF, based on a Credit Suisse index that uses mathematical models to forecast the best- and worst-performing stocks. The index bets against the losers through short sales equaling 30 percent of its assets and then invests the cash in its top picks, creating long positions that equal 130 percent of assets. The ProShares Credit Suisse 130/30 currently has a market capitalization of about $54 million.
BlackRock will initially create a 130/30 fund based on the MSCI USA Barra Earnings Yield index, according to the company’s application. This index uses mathematical models to buy companies with “positive earnings momentum” and sell short those that have negative earnings momentum, the filing said.
“In seeking to achieve its investment objective, each new fund will utilize passive indexing investment strategies,” BlackRock said in the filing. BlackRock also said that the new ETFs “anticipate using securities lending to a greater extent” than existing funds to facilitate their investment strategies.