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The biggest players in the short game get a pass
(Bloomberg) – It’s in the air again, on Reddit, in Congress, in Sequel C: Hedge funds that get rich off short selling are the enemy. The odd thing is that the biggest players in the game get a pass, it is asset managers, pension plans and sovereign wealth funds that provide the vast majority of securities used to take bearish positions. . Without BlackRock Inc. and State Street Corp., the California Public Employees’ Retirement System and the Kuwait Investment Authority fulfilling such a basic role, investors such as Gabe Plotkin, whose Melvin Capital Management has become a piñata for day traders in GameStop Corp ., would not have any stocks to sell short. “Every time we sell a stock short, we locate a loan,” Plotkin said on Feb. 18 during the House Financial Services Committee hearing on GameStop’s short squeeze. There are many choices. By mid-2020, some $ 24 trillion in stocks and bonds were available for such borrowing, with $ 1.2 trillion in stocks – a third of all hedge fund assets – in fact on loan. , according to the International Securities Lending Association. This is a situation that, at first glance, defies logic. Given the popular belief that short sellers create unwarranted losses in certain stocks, why would shareholders want to provide the ammunition for attacks on their investments? The explanation is quite simple: by lending securities for a small fee plus interest, they can generate additional income which increases returns. This is essential in an industry where fund managers are paid to beat benchmarks and especially valuable in a world of low returns. The trade-off is simple: for investors with large and diversified portfolios, only one stock is available. collapses under the weight of a short sale. the campaign has little long-term impact. And in the shorter term, the higher the number of overall bets against a stock – the so-called short interest -, the higher the fees a lender can charge. In GameStop’s case, short interest was unusually high. and shares on loan. generated an annualized return of 25% to 30%, Ken Griffin testified at the February 18 hearing. Griffin operates a market maker, Citadel Securities, as well as Citadel, one of the largest hedge funds in the world. “Securities lending is a way for long-time holders to generate additional alpha,” said Nancy Allen of DataLend, who compiles data on securities financing. “Originally it was a way to cover costs, but over the past 10 to 15 years it has become an investment function.” Not everyone is comfortable with the inherent conflict. In December 2019, Japan’s $ 1.6 trillion government pension fund stopped lending its international shares to short sellers, calling the practice inconsistent with its responsibilities as a trustee. At the time, the decision was costing GPIF around $ 100 million per year in lost revenue. The U.S. Securities and Exchange Commission has regulated short selling since the 1930s and has monitored the market for abuses such as naked shorting, which consists of taking a short position without borrowing. actions. Advocates of legal shorting argue that its use increases liquidity, improves prices, and plays a critical role in guarding against fraud and hype. Executives, whose salaries often depend on stock performance, routinely criticize salespeople to discovered like vultures. More recently, the short has been criticized in the emotionally charged jokes on Reddit’s WallStreetBets forum. Some speculators jacked up the prices of GameStop, AMC Entertainment Holdings Inc. and other stocks even in January to punish hedge funds that bet against them, and they rejoiced when the frantic buying led to deadly losses at Melvin, Maplelane Capital and Citron Research. Many key players in the GameStop frenzy testified at the February 18 hearing. Plotkin was toasted by committee members on Melvin’s short position. Citadel’s Griffin and others have faced broader questions about short selling. Yet no one has questioned the offering of the borrowed shares and no witnesses have been called from the securities lending industry.There is a symbiotic relationship between hedge funds and blue chip brokerage units of companies. of Wall Street, largely based on securities lending. Blue-chip brokers act as intermediaries, procuring stocks and bonds for borrowers who wish to sell them short and facilitate transactions. According to DataLend, securities lending generated $ 2.9 billion in broker-to-brokerage revenue in 2020, almost the same as in 2019. Demand for short positions is already expected to decline as stock prices hit record highs unprecedented. Now, with the threat of retaliation from the Reddit mob, he can weaken even further. Griffin said he had “no doubt” that there will be fewer short sales due to GameStop compression. “I think the whole industry will have to adapt,” Plotkin said at the hearing. “I don’t think investors like me want to be sensitive to these types of dynamics.” This could threaten not only the brokers who negotiate securities lending, but also the holders who provide the securities and share the income. They raised $ 7.7 billion worldwide in 2020, up from a record high of nearly $ 10 billion in 2018, according to DataLend. Lending fees rose 4.2% year over year in February after the GameStop attack, according to DataLend. Although securities lending accounted for $ 652 million, or just 4%, of the BlackRock’s revenue in the fourth quarter of 2020, there are low costs and low risks because borrowers must provide collateral equal to or greater than the value of the loan. At BlackRock and State Street Corp., the second-largest depository bank, the value of securities loaned as of Dec.31 jumped at least 20% from the previous year, to $ 352 billion and $ 441 billion , respectively. counts with indexes, ”said John Rekenthaler, vice president of research at Morningstar. “You scratch nickels in the street, but there are a lot of nickels.” Others could also suffer a blow. Just as Robinhood Markets is able to offer commission-free transactions by selling its order flow to Citadel and other market makers, asset managers typically pass a portion of their securities lending income as a type of customer discount. Institutional investors derive substantial benefits from their participation in the securities lending market, ”Citadel Griffin said during the GameStop hearing. “It benefits pension plans, ETFs, other institutional loan pools that participate in the securities lending market.” (Adds loan fee data after short interest rate chart.) 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