The Hedge Fund Betting on a Credit ETF Implosion

via Bloomberg:

After quitting his job at a $7 billion hedge fund to go it alone three years ago, Adam Schwartz happened upon a short so certain he built a notional position amounting to half his fledgling firm’s assets on it.

He’s been borrowing shares and stockpiling bearish options on exchange-traded funds that track major credit indexes, confident that a blow-up in fixed income will hit these passive vehicles the hardest.

Schwartz reckons it’s only a matter of time before rising rates choke off financing for highly leveraged companies, spurring a wave of bond defaults.

But running a hedge fund with mostly his own cash has given the 39-year-old freedom to bet on more extreme scenarios, like the one where credit ETFs — which have vaulted to prominence promising liquidity comparable to stocks — perish in the bloodbath.

“The ETF structure isn’t really designed for a large market sell-off,” Schwartz said by phone from Miami. “They will break if people don’t trust that they have the liquidity that they think they do today.”