Will short selling ever return to pre-credit crunch levels?
With 2010 coming to a close it is worth debating whether or not the demand to borrow shares will materially increase in 2011. Would anyone like to wager whether the Data Explorers peer group will be lending/borrowing over $2tr by this time next year? The key pillars to ongoing borrowing demand are: offshore hedge funds, UCITS III funds, ETFs and Convertible Bond issuance.
The stock market in the UK has been given one last shove with a national newspaper (Daily Telegraph) reporting that it is a “waste of time” putting money into a savings account given low interest rates and rising inflation. Everyone already knows this with the Bank of England reporting only 3.2% of income being saved each month! Will people turn to the stock markets for income and capital growth and will this mean people will want the cream of the crop to manage their money via UCITS III funds or will they choose passive investment strategies via ETFs? Both of these routes are of use to the securities lending market.
If, as an investor, you believe that stock markets are incredibly tricky to navigate then choosing a hedge fund manager is an obvious choice. UCITS III has enabled people like GLG, Marshall Wace and Paulson (this week via DB’s platform) to attract retail investors. But , a recent report by Kepler Partners, shows that there is under $80bn in these funds so far (for UK registered funds). Take up has been slow for a variety of reasons andbut they need to gain in popularity quickly to make a decent impact in the volume of stock borrow given their ability to short sell to make money for their investors. The arrival of big names like Paulson, which raised $100m on launch, will help.
But, UCITS III is not the first dalliance with the common man undertaken by famous hedge fund managers. Quite a few have listed Investment Trusts that could also be useful hedging instruments if their liquidity was up to it. 2% of the Fidelity China Special Situations fund (LON:FCSS) shares are short which is a large proportion of supply. This may represent a hedge against being long other names in China and also since there is an 8.7% premium to the value of its underlying holdings. Conversely, to name but one, the Sloane Robinson Europe (SR Europe) fund is currently trading at a 19% discount to their NAV!
But what of the wider popularity of (offshore) hedge funds? In our recent quiz we drew attention to Hedge Fund Review reporting the largest quarterly inflow into hedge funds in Q3 of this year to the tune of $120bn. This compares with a total AUM of $1.7 trillion, according Absolute Return. There are also reports of pension schemes enjoying the diversification benefits of hedge funds and allocating increasing assets. This accords with a recent quote (in Absolute Return magazine) from founding father Julian Robertson of Tiger fame, “this is a great time to consider opportunities, especially given investors’ evolution towards alternative investment.”
This is despite the somewhat disappointing returns this year compared to the major indices with the S&P500 up 11.33% YTD versus 4.4% of a composite of European hedge fund strategies (according to Eurohedge). Value investing – one of the core skills of active mangers – is still struggling. This brings us onto ETFs which have just over $1tr AUM as at the start of Q3 this year according to Blackrock. Given the popularity of these ETFs as hedging instruments, their prolificacy is good news for securities finance.
New ETFs are coming out all the time but many retail investors, especially in Europe, still don’t understand them and masses of education is still required, not to mention the need for financial advisers to have an incentive to sell them to their retail clients instead of managed funds. Interestingly, professional investors such as Bridgewater like this asset class, with a $3.4bn holding in emerging markets ETFs accordingly to public filings.
Passive investing via ETFs has been taken to another level with the break out of “clone” investing tools such as Alpha Clone. This collates all publicly disclosed US equity positions and enables investors to back test which of the fund management stars in they would like to follow. If you had invested in Warren Buffet’s top 10 holdings as opposed to owning shares in Berkshire Hathaway (his public shares) you would have made more money! This is a fascinating “third way” way for those that like hands on investing that piggy backs on other people’s research.
Convertible bond issuance next year is anyone’s guess. Ford recently redeemed a bond that led to over $3bn of loans being returned. GM issued something similar on their IPO. Big companies known to be issuing new CBs next year (according to dealReporter) are Alcoa (NYSE: AA), Johnson Controls (NYSE:JCI), MF Global (NYSE:MF), Newmont Mining (NYSE:NEM), Saks (NYSE:SKS), SunPower (NASDAQ:SPWRA). At least this group of companies should see an uptick on borrowing demand. Anyone want to guess the balance on loan this time in a year?
