Hedge Funds, Volatility, and the Securities Lending Market

Newspaper with computer on table

The trading desk has received a number of queries over recent weeks asking if we have seen a material uptick in lending activity as a result of the increased volatility in the equity markets. The short answer – it’s too early to say. In this post, Robert Lees, Global Head of Securities Lending Trading, offers his perspective on the dynamics at play.

The trading desk has received a number of queries over recent weeks asking if we have seen a material uptick in lending activity as a result of the increased volatility in the equity markets.  The short answer – it’s too early to say.  Bloomberg recently published an opinion piece, “Hedge Funds Finally Got Some Volatility. It Didn’t Help” which seems to agree with that sentiment.

Of course, there is a more nuanced story behind the answer.  Most markets and asset classes have been at all-time highs and, at the other end of the spectrum, volatility and interest rates at all-time lows.   As interest rates begin to rise and inflationary pressure returns, we appear to be transitioning to a “newer normal” where the market refocuses on fundamentals.  This reevaluation of expectations could lead to an increased dispersion in equity valuations and cause stock picking to have greater importance.  The expectation is that this would in turn lead to an increase in securities lending demand as short conviction increases.

In addition, M&A and IPO activity is expected to rise, encouraged by the strength of the global economy and historically high corporate cash levels.  These factors could create a boon for activity and, consequently, lending demand.   Separately, as the US economy continues to expand, it’s likely that the Fed will increase rates more aggressively in 2018. This could cause capital to flow out of emerging markets as debt valuations adjust to higher costs. Outside the US, we also expect that a weaker dollar and talks of potential tariffs could have a significant impact on exporting economies as well as individual corporations with significant exposure to the largest economy in the world.

While the recent spikes in volatility are noteworthy, it is important to keep the focus further down the road the where the drivers for increased demand for securities lending look particularly encouraging.