Insights from Our Equities Desk - Issue 1, 2014
Global equity markets had a strong final quarter to 2013 with the S&P rising to an all time high and its best return since 1997, and European and the Japanese markets at 5 ½ year highs.
The U.S. Federal Reserve Bank announced it would begin to taper its asset purchases from $85 billion to $75 billion a month from January, but committed to keeping interest rates at current record lows. Despite equity markets being driven higher in 2013 on the back of monetary stimulus, the Fed tapering news was received positively by investors as the threat of an early interest rate hike receded and as the global economy continued to strengthen. In the securities lending market, the fourth quarter continued much the same as for the rest of the year, with a lack of shorting and specials (although with a pick-up in the U.S. towards the end of the period), volatile European dividend trading and good lending activity around capital raisings.
Directional shorting activity continued to be weak especially in APAC and EMEA. We did however see an increase in specials activity in the US. Stocks where demand increased included ExOne, IPG Photonics, Vivus, Arena Pharmaceuticals, Tesla Motors, Halcon Resources, Mindray Medical, Questcor Pharmaceuticals, Windsteam, Dendreon, Polypore and InterOil. U.S. ETF’s were also in demand, particularly in emerging markets as hedge funds took a directional view on the impact of Fed tapering on emerging market securities. In demand were iShares Emerging Market Bond ETF, iShares MSCI Emerging Markets ETF and Vanguard FTSE Emerging Markets ETF. In Japan we saw demand increase for key specials including Gree, GungHo Online Entertainment, Mitsubishi Motors, Dena and Mizuno. In Taiwan revenue continued to come under pressure as increased supply came up against demand constraints caused by regulatory limits on the amount of stock that can be shorted. In Canada revenue came off as short interest decreased in BlackBerry and Westport Innovations, two long term specials.
Capital raisings continued to be a big driver of revenue as companies continued to take advantage of strong equity prices to strengthen balance sheets and fund takeovers. Australia was very active with companies including Bentham IMF, G8 Education, FKP Property Trust, Medusa Mining, Virgin Australia and Ausenco, plus we saw a meaningful increase in IPO activity as we lent stock in McAleese, Dick Smith, Nine Entertainment and Pact Group. In Japan we lent shares in Mitsubishi Motors, Nichi-iko Pharmaceutical and Sanrio. In Europe we lent shares off the back of capital raisings by Abengoa of Spain; Portugal Telecom of Portugal; Nexans, Rubis, and Alcatel-Lucent of France; and Evonik Industries in Germany. In the U.S. Twitter was the big event with high demand from borrowers with the stock remaining special through the quarter.
Lending opportunities from M&A activity remained few and far between. The American Airways/US Air merger generated significant borrower demand for US Air, and the merged shares remained in demand from a directional perspective after the deal had closed. M&A activity in Australia increased with takeovers/mergers between Austin Engineering/Bradken, CFS Retail Property Tst/Integrated retail asset mgt, and IAG/Wesfarmers, although demand to borrow varied depending on the stock.
USD overnight repo rates dropped to near zero over the end of the year, but this was offset by a near zero Fed Funds open level (benchmark rate for rebates). Overall impact to the book was positive as spreads increased. We also saw a general reduction in cash balances over year end with borrowers swapping into non-cash collateral as they managed balance sheets.
Q4 was an active month for dividend trading. In France we lent shares in GDF Suez, Orange and Total. Trading levels were strong and feedback from borrowers was this was due to shorting activity in the market leading to a general increase in demand for French equities, especially low dividend stock over dividend record dates. Levels in Italy were lower for stocks like Snam, Terna and Atlantia as a lack of balance sheet at end users and the impact of the Italian financial transaction tax took their toll. In Brazil we traded several stocks for the IOC, including Vale which was the biggest revenue generator of the year. In Japan balances came off significantly as the September dividend trades were unwound, but did increase towards the end of December for that month’s dividend record date. As mentioned in previous updates we believe the recently announced higher rate of withholding tax should lead to greater demand and higher fees on these trades going forward.
Hedge funds had a positive year in 2013 up 9.33% in aggregate. Equity long short funds were up 14.6% marking the strategy’s best annual performance since 2009. Short biased funds however had negative performance of 1.08%, highlighting the headwinds faced by short sellers in the current market environment.
APAC - Expect investor interest to be focused on the long side, as Abenomics continues to drive the Japanese market, and as China adopts market friendly reforms and the economy heads for a soft landing. This will keep demand for directional shorts subdued, continuing the 2013 trend. With strong markets we do see potential for increased deal activity and capital raisings. There is a risk of course that China may not be successful in its attempts to restructure the economy and engineer a soft landing, in which case we would expect to see more shorting activity.
EMEA – expect continued volatility in the dividend business as banks reduced their capacity in 2013 and continue to be selective on the stocks they’ll take due to capital constraints. With the improving economic situation and the debt crisis seemingly under control, we expect investor interest to be weighted towards the long side with limited shorting activity, although improved company earnings should result in higher actual dividends in 2014 which will be positive for revenue. Capital raisings were a big driver of lending revenues in 2013 and we expect this to continue into 2014.
Americas – U.S. specials activity picked up towards the end of 2013 with prime brokers reporting increased shorting interest by hedge funds. The view that certain companies have ridden the overall market higher and are overvalued should lead to more shorting and specials activity in 2014. Canada we expect to be driven by dividend trading, and in Brazil we expect increased shorting after activity slowed down in the second half of last year as the market rallied from its low point.
Hedge Funds – although hedge fund performance again lagged equity indexes in 2013, investor appetite remains strong for this form of investment management. Equity and event driven strategies in particular have been popular with investors and we expect further growth in 2014 which should be positive for demand to borrow (subject to market conditions).
General – capital and balance sheet concerns will continue to dominate borrower behavior. Term financing including evergreen trades (where the term date is extended daily) and collateral flexibility will be a big focus, and the demand for low spread trades will continue to come under pressure (poor return on capital).