WHEN EVERYONE else was bracing themselves for turkey and plum pudding last month, City fund managers were busy behind the scenes, borrowing stock they did not own in the hope of pocketing a profit.
That is the message from figures showing that, in December, institutional investors lent out no less than 20.3% of the shares in supermarkets group Wm Morrison, 23.4% of pubs operator Mitchells Butlers, 20.2% of Man Group, 19.7% of software house iSoft and 10.6% of Arm Holdings. These statistics, released by stock market settlement company CrestCo every month, give private investors a rare and valuable glimpse of the cloak-and-dagger manoeuvrings of the City’s big battalions.
Heavy stock lending often reflects short-selling by hedge funds hoping to profit from a share-price fall. Man Group shares, for instance, have been a regular target of shortsellers sceptical about its spectacular success. The same may go for Lastminute.com, which saw 12.1% of its shares lent out in December. However, a high percentage of lending in a stock can also be the result of arbitrage or tax avoidance strategies by large investors.
Independent securities and derivatives expert Dominic Connolly says the heavy stock lending in Morrison is likely to be due to “risk arbitrage” connected with that firm’s takeover of Safeway.
“The Morrison bid is one of its own shares plus 60p in cash for each Safeway share. Earlier this week, I could buy Safeway at 2831/ 4p and sell Morrison at 2241/2p. If the bid goes ahead, in three weeks, I would receive a Morrison share plus 60p, or 2841/2p in total, giving me a profit of 11/4p a share.
“That is typical of the ‘arbitrage straddle’ that occurs with paper bids.
People buy one share and borrow the other, immediately selling it on, producing a net short position. Their risk is that the deal falls through at the last minute,” Connolly says.
Mitchells Butlers says that many of the 111 million of its shares on loan in December are likely to have been connected to its payment of a 68p-a-share special dividend late in 2003.
“There is a tax break on dividend income in France if a stock is held for two months,” it says. “A number of French banks have entered stock-lending agreements with UK institutions so they receive the special dividend and can claim back the associated tax credit.”
Changes in the amount of stock lending may tell a story. Bearish investors in Hays and Corus seem to be losing out because the proportion of those two firms’ shares lent out fell from 12.4% and 10.8% in November to 6.3% and 8.4% in December. However, for both Rolls-Royce and SkyePharma, the amount edged up between those months, from 7.7% to 8.6%, and from 8.5% to 9.1% respectively.
One expert on stock lending says: “If you have allowed for any special factors and still see the percentage of lending increasing on a stock, you can conclude that some large investors are taking a negative view.” This does not necessarily mean the stock will go down – the hedge funds might have got it wrong, in which case a rising share price would squeeze their short positions, forcing them to buy shares to reduce their exposure, hence driving up the price even faster.
However, Daniel Birch, market strategist at stockbroker Execution, says: “If there is a lot of short interest in a stock, that means it may be volatile in both directions, and that is a useful piece of information for investors to know.”
Stephen Grainger, product manager at CrestCo, says a high incidence of stock lending can also be connected to the “voting season”. Sometimes institutions borrow stock from other funds ahead of a company’s annual general meeting in order to increase their voting power on a contentious resolution.
