On a positive note
19 February 2019
Robert Lees of BBH suggests that this year, many of the core themes of last year will continue, leading to another positive year for securities lending returns
Image: Shutterstock
Last year, was a turbulent year for global markets and from a securities lending perspective, it offered numerous opportunities to generate returns in what became a banner year for many lending programmes. This year, we expect many of the core themes of last year will continue leading to another broadly positive year for securities lending returns. With the predicted pace of the US Federal Reserve (Fed) rate hikes slowing down, global growth expectations now moderating, and political risk continuing to be elevated, it is our expectation that securities lending demand will be resilient in H1 this year as investors position accordingly.
In H1 last year, steady growth was observed across all regions and global on-loan balances increased by 10 percent over the same period in 2017, more than offsetting a drop in average spread. This, paired with an elevated level of volatility and greater economic uncertainty associated with events such as Brexit, led to a more diversified, stable and long-term set of loan opportunities across the programme compared to 2017, where opportunities were in a concentrated number of stocks. Over the second half of the year, news headlines dominated the markets as trade-tariff based rhetoric, concerns about accelerated monetary policy in the US, and a much-anticipated market correction in October, caught many investors off guard. This erased much of the gains experienced in 2018 and led them to take a 鈥榬isk-off鈥� stance. This has led to a marked change in the lending environment, with higher volatility in lending volumes and lending fees as fund managers look to de-risk, cut losses or take a 鈥榮it it out鈥� attitude.
In the Americas, demand has been driven by many factors. The foremost is the worsening consumer sector, as online giants continue to change the way consumers purchase products. The legalisation of cannabis products in Canada has spawned a significant level of borrowing demand as speculation persists whether supply will match the amount of real demand. Many cannabis producers went public in Canada early on, post legalisation, thus priming the market for mergers. Stock prices remain extremely volatile in this sector. Rising interest rates are putting short term corporate bonds under pressure, as many struggling corporations are finding it hard to meet their short-term obligations. As interest rates continue to rise, this will only intensify, and many short-term bond exchange-traded funds (ETFs) are attractive to borrow as hedge funds short the sector.
As we move throughout this year, we expect a much different economic landscape in the US than in 2018. The predicted speed of rate hikes has decreased, oil prices have dropped precipitously, and markets have been disrupted. The expectation is that funds will be as active as they were to start 2018 but understanding of the new landscape. The hedge fund market saw minimal outflows and has seen many new high-profile start-ups in 2018. Demand is expected to be resilient in H1 2019.
In Asia, lending demand has been driven by a combination of themes, not least by the escalation of the US/China trade war which led to an increase in volatility across the region. In Hong Kong, demand has been buoyed by a strong pipeline of initial public offerings and broad capital raising activity, particularly in the e-commerce and technology sectors. In Japan, an increase in corporate scandals and merger and acquisition deals has provided additional impetus for lending demand. Tightening Chinese government regulations in the online game sector has negatively impacted developers across the region. Particularly developers based in China, Japan and South Korea, were further affected by the selloff in the global technology sector in Q3/Q4 2018. Lastly, in South Korea, we have witnessed robust demand in the biotech and pharmaceutical sector on investor concerns that these sectors were overvalued after a strong market rally that began in 2017. As we move throughout the year, demand in the education sector may increase as a result of potential further regulation that will negatively impact private educational operators. Additionally, Chinese automobile manufacturers continue to be a popular short as the industry is beset by a broad slowdown in demand for vehicles.
In Europe, political uncertainty and a weak consumer environment have proved to be key drivers for lending demand. Demand for retail providers, particularly in the UK, has been strong as several high street names announce store closures, restructuring plans and poor sales because of rising costs and poor seasonal revenue. In Italy, banks continue to face headwinds as the economy continues to stumble. Finally, across the continent, lending demand has increased for companies within the construction sector as output has fallen, contract uncertainty has grown and contagion from the collapse of one of the UK鈥檚 largest contracting firms, Carillion, has led many to wonder what was in store for similar firms.
We expect many of the themes affecting lending demand to continue in Europe throughout the year with no respite for the retail markets. We expect Brexit to continue to dominate headlines in the first half of the year as the UK Prime Minister Theresa May seeks to close divisions within parliament and hopes to ensure that a deal is agreed upon prior to the 29 March deadline. The outcome of the final deal could have large ramifications for aerospace, automobile and manufacturing industries in the UK and throughout Europe.
In conclusion, we expect lending demand to be steady in H1 2019, albeit masked with extra cautiousness. The market volatility in Q4 2018 has led to a period of de-risking and hedge fund performance in the second half of 2018 came in below expectations. Additionally, several macro headwinds could negatively impact borrowing demand, such as a rapid escalation of the US/China trade war, a sharp economic slowdown in China and an increase in political tensions across Europe.
In H1 last year, steady growth was observed across all regions and global on-loan balances increased by 10 percent over the same period in 2017, more than offsetting a drop in average spread. This, paired with an elevated level of volatility and greater economic uncertainty associated with events such as Brexit, led to a more diversified, stable and long-term set of loan opportunities across the programme compared to 2017, where opportunities were in a concentrated number of stocks. Over the second half of the year, news headlines dominated the markets as trade-tariff based rhetoric, concerns about accelerated monetary policy in the US, and a much-anticipated market correction in October, caught many investors off guard. This erased much of the gains experienced in 2018 and led them to take a 鈥榬isk-off鈥� stance. This has led to a marked change in the lending environment, with higher volatility in lending volumes and lending fees as fund managers look to de-risk, cut losses or take a 鈥榮it it out鈥� attitude.
In the Americas, demand has been driven by many factors. The foremost is the worsening consumer sector, as online giants continue to change the way consumers purchase products. The legalisation of cannabis products in Canada has spawned a significant level of borrowing demand as speculation persists whether supply will match the amount of real demand. Many cannabis producers went public in Canada early on, post legalisation, thus priming the market for mergers. Stock prices remain extremely volatile in this sector. Rising interest rates are putting short term corporate bonds under pressure, as many struggling corporations are finding it hard to meet their short-term obligations. As interest rates continue to rise, this will only intensify, and many short-term bond exchange-traded funds (ETFs) are attractive to borrow as hedge funds short the sector.
As we move throughout this year, we expect a much different economic landscape in the US than in 2018. The predicted speed of rate hikes has decreased, oil prices have dropped precipitously, and markets have been disrupted. The expectation is that funds will be as active as they were to start 2018 but understanding of the new landscape. The hedge fund market saw minimal outflows and has seen many new high-profile start-ups in 2018. Demand is expected to be resilient in H1 2019.
In Asia, lending demand has been driven by a combination of themes, not least by the escalation of the US/China trade war which led to an increase in volatility across the region. In Hong Kong, demand has been buoyed by a strong pipeline of initial public offerings and broad capital raising activity, particularly in the e-commerce and technology sectors. In Japan, an increase in corporate scandals and merger and acquisition deals has provided additional impetus for lending demand. Tightening Chinese government regulations in the online game sector has negatively impacted developers across the region. Particularly developers based in China, Japan and South Korea, were further affected by the selloff in the global technology sector in Q3/Q4 2018. Lastly, in South Korea, we have witnessed robust demand in the biotech and pharmaceutical sector on investor concerns that these sectors were overvalued after a strong market rally that began in 2017. As we move throughout the year, demand in the education sector may increase as a result of potential further regulation that will negatively impact private educational operators. Additionally, Chinese automobile manufacturers continue to be a popular short as the industry is beset by a broad slowdown in demand for vehicles.
In Europe, political uncertainty and a weak consumer environment have proved to be key drivers for lending demand. Demand for retail providers, particularly in the UK, has been strong as several high street names announce store closures, restructuring plans and poor sales because of rising costs and poor seasonal revenue. In Italy, banks continue to face headwinds as the economy continues to stumble. Finally, across the continent, lending demand has increased for companies within the construction sector as output has fallen, contract uncertainty has grown and contagion from the collapse of one of the UK鈥檚 largest contracting firms, Carillion, has led many to wonder what was in store for similar firms.
We expect many of the themes affecting lending demand to continue in Europe throughout the year with no respite for the retail markets. We expect Brexit to continue to dominate headlines in the first half of the year as the UK Prime Minister Theresa May seeks to close divisions within parliament and hopes to ensure that a deal is agreed upon prior to the 29 March deadline. The outcome of the final deal could have large ramifications for aerospace, automobile and manufacturing industries in the UK and throughout Europe.
In conclusion, we expect lending demand to be steady in H1 2019, albeit masked with extra cautiousness. The market volatility in Q4 2018 has led to a period of de-risking and hedge fund performance in the second half of 2018 came in below expectations. Additionally, several macro headwinds could negatively impact borrowing demand, such as a rapid escalation of the US/China trade war, a sharp economic slowdown in China and an increase in political tensions across Europe.
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