Some London Institutions Finally Limit Stock-Lending

by Philip Morton, InvestorsOffshore.com

27 September 2001

After two weeks in which accusations that hedge funds were worsening market falls by aggressive short-selling were strongly denied by the funds, and rumours of bans on stock-lending were quickly discounted by major equity market players, some London institutions have now moved to limit stock-lending. In the case of insurance companies, it appears that the impetus has come from the Financial Services Authority, but in the case of banks the moves may have more to do with protecting the interests of their own clients than with altruism or concern for the general level of the market.

For instance, HBOS, the bank created after the merger of Halifax and Bank of Scotland, yesterday stopped lending shares in the mid-cap stocks in which it specialises, saying that in current market conditions it didn't want to help short-sellers to cut away support from assets widely owned by its own client investors.

In a statement, HBOS said: "In the current market climate, the profits to be made from stocklending are dwarfed by the damage that short-selling activities are inflicting on the life savings of ordinary investors across the UK. It is therefore time to call a halt to this practice."

Other firms claimed to be protecting the market. Foreign & Colonial scaled back its stocklending last week, rejecting fresh loans without recalling its existing loans. "This is a snap reaction to market turbulence. We did have a concern about hedge funds that were shorting the market and we didn't want to be involved in that," said Jeremy Tigue, the manager of Foreign & Colonial Investment Trust.

For those who believe that the short-selling activities of hedge funds and other market players are a major contributor to liquidity, any limitation on stock-lending (which is the obverse of a short sale) is negative. While short selling is far from the only purpose behind a need to borrow stock, other purposes linked to derivative transactions are equally helpful for liquidity.

Andrew Spears, the European head of securities lending at Barclays Global Investors, said: "Lending is a key component of liquidity in the market and an important function at this time."

In fact, most hedge funds have not increased their short positions since the attacks in America, preferring instead to move into cash or other market-neutral positions during a period of turbulent trading. Unlike in 1998, when many hedge funds had a positive view of market prospects and were caught out by the suddenness of the Asian crisis that brought down LTCM, most hedge funds already had a bearish view in July and August, and were short rather than long when disaster struck.

If there is a problem lurking in the hedge fund jungle at present, it is less likely to be the gearing of major players (that lesson has been learnt) than the inexperience of some operators as the hedge fund universe expands dramatically. Earlier this year Morgan Stanley strategist Barton Biggs warned of some of the risks: "Several corners of the industry, particularly converts and long-short strategies, show signs of incipient mania, at least to me," he said in a report, explaining that the industry's 6,000 funds, with $400 billion under management, was an order of magnitude bigger than it was in 1998. "I'm sure a sizable number of the new funds will explode and their investments will lose a lot of money, but that would be a minor event that would cause barely a ripple," Mr. Biggs added.

Others are more sanguine. "The really, really big difference is that the amount of leverage in the system relative to three years ago is much smaller, because we learned some lessons in 1998," Todd Petzel, chief investment officer for Common Fund, told the Wall Street Journal. "The prime brokers and suppliers of credit have kept managers on tight reins."

Because of the predominantly bearish attitude of most hedge funds before the disaster on September 11th, this month's performance for many hedge funds sectors will probably be much better than their fairly lacklustre results earlier in the year. But if that turns out to be so, it will be due to the positions they held before the disaster rather than anything they might have done since. Fund sectors which may have benefited particularly should include Global Macro, Convertible Arbitrage, and Event-Driven. Long/Short Equity, which accounts for 47% of hedge fund assets will probably have remained comparatively flat, and like all funds, will have tended to be long on cash while conditions remain unpredictable.

 

.

Recommended

Write a comment