Hedge funds appears to lack savvy to get the best terms available when borrowing or lending securities, according to a report by managing principal Josh Galper of Vodia Group. According to an analysis by the Concord, Mass.-based firm, “Hedge funds are failing to receive payments of 75 basis points on the value of their short portfolios. That means, hedge funds lose about $3 million on a $500 million short portfolio.” Galper tackles what he calls for myths of securities lending:
Myth 1: There is one securities lending market for hedge funds. That may be true for prime brokers and custodians, but not so for hedge funds, says Galper, arguing that they could find better rates “by comparing lenders, understanding how rates are affecting the fund’s positions, and by seeking out alternatives that place a higher value on a particular fund’s borrowing needs than the fund’s initial Prime Broker may have.”
Myth 2: Only prime brokers can lend stock. Prime brokers, Galper writes, are primarily intermediaries in the business of lending stocks. He notes, “Hedge funds at all levels can borrow securities to short and can lend long positions out to be shorted through multiple channels. Hedge funds can call on brokers with Depository Trust Co. clearing numbers to lend out long securities on the fund’s behalf.”
Myth 3: Securities lending desks are taking unfair advantage.This notion that securities lending desks are marking up rates is “itself typically unfair,” Galper says, pointing out that these desks “can only charge their clients what their clients will pay.” He stresses that” it is the hedge fund’s responsibility to know what appropriate rates are for their positions and either ask for those rates or change providers."It’s easy to do that these days, he says, as funds can “run a fast daily price check on their portfolio.”
Myth 4: Hedge funds must do all their borrowing business with their prime brokers. While prime brokers would love exclusivity and impose “hefty conditions:" for doing business elsewhere, it “does not change the premise that hedge funds have a world of choice when it comes to their securities lending activity.”
Galper concludes that education is key: “When it is time to talk with your Prime or custodian about your borrowing decisions, you must speak the right language or else fall into the trap of ignorance.”