Malt Liquidity 23
Sometimes ETFs and liquidity aren't that interesting. Who would have thought?
A Supposedly Fun Thing to Write About…
An article came across my desk this morning that seemed like fate for me to write about (Credit ETFs Cause a Liquidity Problem and then Sell the Solution) but honestly, there isn’t really much to be said about this topic. The gist of the article essentially points out that bonds held by ETFs are much more liquid by virtue of being tradeable through the ETF, and the bonds not held by ETFs have their transaction costs noticeably increase. This is the exact service the ETFs are supposed to provide - they provide intraday, liquid access to a basket of assets that you’d otherwise need to transact through a potentially illiquid spread
They found ETFs cut the cost of trading junk bonds in particular. Over the period, transaction costs for securities added to the $24 billion iShares iBoxx High Yield Corporate Bond ETF (ticker HYG) fell by 14.4 basis points, or 14%.
while managing the net effect those trades have through creation/redemption at the end of the trading day. In fact, I would even deem “cause a liquidity problem” to be an unfair charge, because ETFs are not required to package together any and every security - they provide liquid access to products because they see a return in it. A constant discussion in the ETF liquidity niche revolves around the distortions ETFs can cause in the market, and whether an “ETFpocalypse” event can happen where ETFs across the board are so distorted from the underlying that the result is a “doom spiral”:
Rampant volatility in bond markets makes it unappealing for middlemen known as authorized participants to step in to equalize the value of the ETF and the bonds underlying it. In normal times, the price dislocation would spur them to buy shares of a falling ETF in order to exchange them for the underlying bonds with the fund’s issuer, capturing a virtually risk-free profit.
Now, with stress mounting, fears are rising that investors rushing to redeem ETFs will exacerbate a sell-off in the underlying market as authorized participants channel bonds out of the fund. The rampant volatility has made it more difficult to unload the underlying bonds.
Admittedly, March was a time where this worry was appropriate! And I have long theorized that a “doom” scenario would revolve around the massive influx of money tied to proxy stocks (in the form of shares in an ETF) demanding too much liquidity out of the actual underlying contents in the case of an extreme, overall market drop. But with the Fed providing so much bond market liquidity, at least in the case of bond ETFs, I think some sort of “ETF redemption bond value death spiral” is nothing to worry about. Alas, this article truly was bait.
…that I don’t want to write about again.
The humor of markets in the past year has constantly been themed “retail buys meme stocks, and institutions create SPAC meme tickers”. And the cultural moment has revolved around people watching whatever the Netflix algorithm pushes in front of them, be it Tiger King or, of course, Queen’s Gambit. But what has constantly shocked me is how much money is continuing to be poured into these memes:
The [Queen’s Gambit Capital]… SPAC, said in a statement Tuesday that it sold 30 million units for $10 apiece, confirming an earlier report by Bloomberg.
The company initially filed in December to raise $225 million. It had elevated that target this month to $275 million, according to filings with the U.S. Securities and Exchange Commission.
It is surreal to me that investors keep piling money into SPACs when they are insanely valuable deals for the SPAC partners specifically as opposed to everyone else, given the current IPO climate where everything just doubles on IPO day. Matt Levine (of course) has a great explainer, but the essential risk profile of a SPAC for the proprietor is a call option whose premium is funded by external investors where, if they find a company to “blank-check IPO”, the option converts to a 20% stake in the company with no mandatory lockup. And, worst case, if they can’t find a company to take public with the cash raised, they return your cash to you (plus “interest”, which hasn’t been a thing since frosted tips). This is a ridiculous lack-of-value proposition if it is highly likely that your stock is going to pop to an insane degree on the IPO - you’re diluting your shares massively! You might ask “then why does anyone take their company public through a SPAC?” Well, compliance costs for public companies are much higher on average. Preparing an S-1 for an IPO is not cheap! But SPACs are already public, so they’d take your company public through a reverse merger - technically, they are doing the due diligence, and reverse mergers are notoriously not nearly as compliance-heavy as going public through the traditional route would be. So, to reiterate: companies taken public by a SPAC are avoiding full compliance costs and giving up around a fifth of their company’s stock to do so while a group of partners use raised investor capital to complete the transaction. I suppose the SPAC’s value add is that they’re really really good at finding these companies and totally aren’t cashing out as quickly as possible.
Oh, by the way, how are the makers of Queen’s Gambit doing?
Pretty well, it seems:
Netflix Inc. ended last year with more than 200 million subscribers, a milestone powered by consumers left homebound by the pandemic, eager for entertainment, and rising demand in international markets where the streaming giant has a head start over many rivals.
The company said it is now able to generate more cash than it needs, and no longer anticipates having to borrow money to fuel its growth strategy.
I have long grumbled about how branding means too much in Netflix’s case, because as content providers demand all their shows back for their own streaming services, their back-catalogue remains bereft of content. Netflix’s answer to this was to spend gobsmacking amounts of money on new content production and churn out what I call “autogenerated content” at dizzying rates. But you can’t blitzscale your way into becoming an HBO! (In other words: The Sopranos wasn’t produced in a day, but Netflix burned the cash for it in one.) And then the coronavirus came, and everyone was stuck at home, so naturally everyone bought Tesla during the day and watched Netflix after the market closed. But this is no small news for the stock from a financial standpoint - while debt is super cheap right now thanks to ZIRP, Netflix has already issued a ton of debt. The fact that they have excess cash to burn - as I mentioned yesterday, there is more value in holding unaudited stablecoin “USD proxies” than holding actual USD right now - is huge, as a worthless asset to hold can be utilized both to avoid accruing more interest against “Originals” production along with, you know, actually funding the projects. And for all my grumblings about Netflix’s content, their actual video player is leagues beyond other streaming services, and their treatment of talent is far better than the traditional TV-and-film industry. Much like stocks have little to do with the actual underlying financials, the value of Netflix has very little to do with its content production. They truly made the most out of the lockdown year.
On that note…
