Russia-focused ETF investors pay the price as short sellers cash in

Exchange traded fund investors who chose not to abandon Russia-focused funds before Moscow’s tanks began rolling into Ukraine paid the price on Thursday as prices sank, trading spreads jumped and short sellers cashed in.

The 24.7 per cent plunge in Russia’s flagship Moex index, taking its losses so far this year to 45.7 per cent, sparked sharp losses for ETFs tied to the country.

The VanEck Vectors Russia ETF (RSX) was down 25.5 per cent in midday US trade on Thursday, pushing its losses since the beginning of this year to 47.1 per cent. The iShares MSCI Russia Capped ETF (ERUS) was likewise down 19.5 per cent, cementing a year-to-date loss of 44.3 per cent, and the Direxion Daily Russia Bull 2X ETF (RUSL) tumbled 46.9 per cent, for a fall this year of 74.7 per cent.

And “long and wrong” investors who did try to exit their positions on Thursday potentially faced larger losses still as bid-offer spreads spiked amid the carnage.

The London Stock Exchange issued a rare notice allowing market makers to offer spreads of as high as 10 per cent — twice as much as it permitted for ETFs at the height of the Covid-induced market panic in March 2020. Euronext’s Borsa Italiana also granted market making spread exemptions.

The wider spreads are designed to induce market makers — which may be reluctant to take more risk on to their books at a time of heightened volatility — to continue trading Russia-focused ETFs.

Borrowing costs have also increased for anyone seeking to hedge their exposure by borrowing Russian ETFs in order to sell them short, suggesting demand to short the ETFs outstrips supply.

Fees to borrow RSX, the largest and most liquid Russian equity ETF with $1.03bn of assets, rose to 5.3 per cent on Wednesday, even before the start of the invasion, from 2.8 per cent on Monday and 0.3 per cent in December, according to data from S3 Partners, a specialist data provider.

The fee to borrow less liquid RUSL was 9.8 per cent, S3 said, up from 6.1 per cent in late December, while for ERUS it was 1.3 per cent. All three are well above the average borrow fee of 0.9 per cent for US-listed ETFs as a whole.

Short interest in RSX was equivalent to almost 27 per cent of the free float, according to S3, while for RUSL it was 3.7 per cent. It was 14.4 per cent for ERUS, the second-largest Russian ETF at $408mn.

While these figures are not excessive — 22.3 per cent of shares of the average US ETF are currently on loan — those who shorted the ETFs this year will be sitting on large paper gains, even before Thursday’s market crash.

“In less than two months of 2022, RSX shorts are up $86mn in 2022 mark-to-market profits, a 23 per cent return on an average short position of $369mn,” said Ihor Dusaniwsky, managing director of predictive analytics at S3, of the data as of Wednesday’s close.

ERUS shorts had delivered $17.9mn in year-to-date mark-to-market profits, he estimated, with RUSL shorters making a further $0.93mn, a 43.6 per cent return.

“With Russia stock prices declining we should see increased short selling in the Russian ETFs, as short selling in Russian local stocks is difficult to execute,” Dusaniwsky added.

“The RSX and ERUS ETFs should see the most action as they have more liquid stock loan availability and cheaper short side financing.”