Using a Total Return Swap to Short a Mutual Fund
Summary
The document explains a theoretical way to create short exposure to a mutual fund through a total return swap (TRS). The fund manager would agree to exchange the return on a portion of the fund for a cash return, while moving the corresponding assets into short-term deposits. At the swap’s maturity, the manager receives the fund return from the swap counterparty and can then calculate the fund’s NAV as if that portion had remained invested.
This structure illustrates how derivative exposure could reproduce the economic effect of shorting a fund without directly borrowing and selling its shares. The answer emphasizes that feasibility depends on manager agreement and legal or compliance constraints. It provides no pricing, collateral, liquidity, or operational analysis, and its example is conceptual rather than evidence that a particular fund would offer such a transaction.
Key ideas
- A total return swap can theoretically provide short exposure to part of a mutual fund.
- The manager could hold the corresponding portion in deposits while receiving the fund return through the swap.
- The arrangement depends on the fund manager’s agreement and legal and compliance conditions.
- The description does not quantify swap costs, collateral needs, or counterparty risk.
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# Is it possible to short publicly traded mutual funds? # Is it possible to short publicly traded mutual funds? I'm curious whether it's possible to short mutual funds in any way? I have given it some thought and I guess that in principle, it is possible using a total return swap. However, I'm sure that the hedging costs of the counterpart as well as other reasons make the setting of this kind of TRS prohibitively expensive (nevertheless I saw plenty of TRS on mutual funds that are long one or more mutual funds). Otherwise, replicating the payoff of the short mutual fund with a portfolio of cheap exchange traded funds would be some sort of cheap but profitable trade (given the high fees of mutual funds). Does anyone know whether it is possible to short mutual funds and if yes, how? ## Answer by user34971 (score 2, accepted) https://quant.stackexchange.com/a/70492 In principle yes, but there are some operational and legal details. The steps: - Denote the mutual fund by $F$ (consisting of bonds, stocks, quantum gravity coins, etc) - The crucial step is that the fund manager agrees to enter into a TRS with you and that there are no legal/ compliance barriers, whereby the fund manager receives part of the fund's return from you (the floating part) and pays cash (the fixed part, but can also be floating if you wish). - Let's say the notional you want to short is 10% of the fund. - The fund manager then rotates 10% of the fund into short-term deposits, and the 'new' fund is $F' = 0.9F + 0.1B$ where I use $B$ for the deposits part of the fund $F'$. - At some time $T$ later, the fund manager receives the return from $0.1F$ from you, where $F$ is the original fund at inception of the TRS. The return from $F$ can be deduced from the $0.9F$ the fund manager is still holding. And you receive the cash return from the $0.1B$ the fund manager had in deposits. - Only after the fund manager receives $0.1F$ return from you does the fund manager publish the new NAV of the fund $F'$ which will be thus the same as the new NAV from being fully invested in $F$ from TRS inception to maturity $T$. So whether shorting a publicly listed mutual fund works depends really on the legal and operational stuff. Hope this kind of makes sense.
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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.