Investors are paying more to short sell ETFs. Here’s what that tells us about the market.

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Bloomberg

Michael Burry, former head of Scion Capital Group LLC, who became famous for his calls about the housing market before that crash.

Investors who want to short-sell exchange-traded funds are seeing their costs skyrocket amid recent market volatility, a phenomenon that shines a light on some of the cross-currents in financial markets now.

Short sellers are often known as investors who identify problems with a particular company. They borrow, and then sell, shares of that company’s stock, assuming those problems will cause the price to decline. If that happens, they’re able to replenish the borrowed shares at a lower price and pocket the difference.

But investors with a bearish view on ideas that are bigger than one particular company often use ETFs to express those views. They may believe a particular industry or sector will suffer — or a country or an entire asset class. The S&P 500 ETF Trust SPY, -4.31%  , an exchange-traded fund often referred to by its ticker, SPY, is the biggest, broadest ETF in the world, and also the most frequently shorted.

Related: What is an ETF?

New research from Ihor Dusaniwsky, managing director of predictive analytics at S3 Partners, shows that borrowing costs have surged 40% so far in March as markets have churned.

“The average cost to borrow for the $147 billion of ETF shorts was 75 (basis points) on March 1st, and as of March 18th it has risen 40% to 105 bps,” Dusaniwsky noted. A basis point is one-one hundredth of a percent.

“ETF short sellers, who were paying $3.1 million per day in stock borrow expenses on March 1st are now paying $4.3 million day,” Dusaniwsky wrote. “This increase would amount to yearly ETF stock borrowing costs increasing from $1.11 billion/year to $1.55 billion/year, an increase of $443 million/year, a noticeable hit to an investor’s or portfolio manager’s bottom line.”

It’s supply and demand that’s pushing costs up, Dusaniwsky told MarketWatch. The demand part is straightforward: with investors in a “sell everything” mindset, a lot of people are looking for ways to short-sell securities.

Read: Why are bonds failing to act like a safe-haven as stocks sell off?

Also: How a ‘disorderly’ U.S. dollar is amplifying the stock-market rout and adding to volatility

The supply side of the equation is a bit more complicated. Many traders are leveraging their positions — that is, borrowing money to amplify the bets they’re making. To raise the cash to do that, they put up collateral, in the form of equities and ETFs.

The brokers that lend cash to shorts can take that collateral and re-lend it to generate more income. If the trader that borrowed cash sells some of his or her positions, though, the amount of collateral shrinks…which means the broker has less supply of securities to lend out to would-be shorts… and the cycle goes on.

Read: ETFs, born from 1987 market crash, are so far making 2020 less awful

It’s not the first time the intricate mechanics of short-selling have muddled investors’ plans. MarketWatch reported on one such instance, in which short-sellers had to buy back shares of Tanger Factory Outlet Centers SKT, -5.31%   when it became clear the company would be removed from a popular index tracked by one exchange-traded fund. The forced buying not only pushed the share price up — a fairly common occurrence known as a “short squeeze” — it also pushed Tanger’s market capitalization high enough that it would technically still belong in the index.

In the current moment, Dusaniwsky notes that some fixed-income ETFs are growing in popularity as tools for short-sellers. A well-known high-yield corporate bond fund is fourth on his list of ETFs with the greatest short interest, while an investment-grade corporate bond fund is sixth. As previously reported, there’s been enormous bumpiness in the bond market in the past few weeks.

Some of the ETFs with the highest borrow fees reflect the other big themes of the moment, however. Two leveraged ETFs that take a bearish view on the energy industry are in first and second place, with fees of 18.40% and 13.65%, followed by one that tracks senior loans that has a 10.40% fee. Also in the top 20 compiled by Dusaniwsky: Xtrackers Harvest CSI 300 China Class A ASHR, -3.90%  and the iShares MSCI China ETF MCHI, -0.27%  .

See: Investors are ‘too complacent’ about the possibility of a pandemic, these analysts say