High-yield debt ETFs raise eyebrows with record trades

Trades took place hours before JPMorgan disclosed $2 billion loss

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May 18 (Bloomberg) -- The largest trades on record in shares of two exchange-traded funds that invest in junk debt are attracting attention to the four-year-old market that allows anyone from banks to retirees fast and discreet access to speculative-grade bonds and loans.

The transactions were completed hours before JPMorgan Chase & Co. disclosed $2 billion of trading losses tied to credit derivatives, an announcement that has heightened awareness of big trades in debt markets.

Shares of an Invesco Ltd. ETF that invests in leveraged loans had a record one-day inflow on May 10 that boosted its shares outstanding by 25 percent, according to data compiled by Bloomberg. The same day, an investor used State Street Corp.’s ETF of junk bonds to anonymously obtain as much as $780 million of the debt by swapping shares of the fund.

“Markets are abuzz” over the State Street ETF trade that allowed an unidentified investor to avoid moving prices in the privately negotiated debt market, New York-based CreditSights Inc. analysts Chris Taggert and Nathan Wenger wrote in a report yesterday.

Investors including TF Market Advisors and Pacific Asset Management speculate that the two trades last week are related.

JPMorgan, which said its losses stemmed from trades done by its chief investment office in London, wasn’t involved in the transactions, according to a person familiar with the bank’s positions, who asked not to be identified because the lender’s trades are private. Brian Marchiony, a spokesman for New York- based JPMorgan, declined to comment.

Cantor Brokers Trade

“This is atypical,” said Brian Robertson, a managing director at Pacific Asset Management, the Newport Beach, California-based affiliate of Pacific Life Insurance Co. that oversees about $3 billion. “There appears to be a correlation given that two of the largest trades happened within 24 hours.”

A May 10 trade brokered by Cantor Fitzgerald LP at 2:42 p.m. in New York created about 4.5 million new shares in the PowerShares Senior Loan Portfolio, Bloomberg data show. The trade, which fueled the highest daily volume for the 14-month- old $565.5 million fund, was valued at about $110.3 million.

Earlier that day, an investor exchanged as much as 19.7 million shares in the SPDR Barclays Capital High Yield Bond ETF for the equivalent of about $779.3 million in bonds, Bloomberg data show. The redemption, the biggest since the $11.2 billion fund was started four years ago, came after the investor had accumulated shares over several weeks, according to Knight Capital Group Inc., which brokered the trade.

Betting Without Owning

“He used the ETF to get his exposure initially; he figured it was an easier way to maintain his anonymity,” Eric Lichtenstein, the global head of ETF trading at Jersey City, New Jersey-based Knight Capital, said in a May 14 telephone interview. “It was a unique approach. This was his plan going into it.”

ETFs typically allow individual investors to speculate on securities without directly owning them. Unlike mutual funds, whose shares are priced once daily, ETFs are listed on exchanges and are bought and sold like stocks.

The funds generally don’t buy securities directly when they receive inflows or sell them to meet outflow requests. Instead, an authorized participant receives cash from investors and uses it to buy securities in exchange for fund shares. With redemption requests, the approved participant returns shares to an ETF’s manager and receives securities.

Junk bonds and loans are ranked below Baa3 at Moody’s Investors Service and lower than BBB- at Standard & Poor’s.

Junk Gains

U.S. speculative-grade bonds and leveraged loans both gained about 0.1 percent on the day of the trades, according to Bank of America Merrill Lynch index data and the S&P/LSTA U.S. Leveraged Loan 100 Index.

After the close of securities exchanges that day, JPMorgan disclosed the trading loss in credit derivatives positions that has since roiled debt markets.

The investment in State Street’s fund, which tracks the Barclays Capital High Yield Very Liquid Bond Index, may mark a new way for investors to gain control over a large group of bonds without tipping off other investors. It was likely related to the move in the leveraged-loan fund, said Peter Tchir, founder of New York-based hedge fund TF Market Advisors.

“It’s too coincidental to have these two unprecedented moves going in the opposite direction,” he said.

Bloomberg News

--With assistance from Mary Childs in New York. Editors: Shannon D. Harrington, Alan Goldstein

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