Modern Portfolio Management and the Prudent Man Rule
Jan 1987 (sadly very outdated but perhaps insightful historically)
" the book uses illustrations drawn from such traditionally suspect categories of investment fiduciaries as securities lending, real estate, venture capital, options and futures and repurchaser agreements. An unusual examination of the interaction of the worlds of law and finance, this work will be of interest to fiduciaries who are subject to some from of prudent man rule and all others, including judges, lawyers and investment managers, who are called upon to interpret and apply that legal standard."
page 90 had an interesting indirect discussion of securities lending history and the prudent man rule...
goes pretty far back actually... pretty interesting in that they show the income falling dramatically as more and more institutions entered the picture competing for fees drove the fees collected downward...
no discussion on whether SL in itself wasn't prudent but does point out the if everyone else does it, it must be prudent mentality of innovation.
Wednesday, December 28, 2011
Example of state laws and the prudent man rule
The prudent man rule:
http://en.wikipedia.org/wiki/Prudent_man_rule
Prudent Investment state law example
Notice no mention of security lending.
Note originally:
As with any fiduciary relationship, margin accounts and short selling of uncovered securities are also prohibited.
We know that in order to lend out securities in a brokerage account you needed a margin feature and yet today we have institutions lending out stock in volume... what the heck happened to fiduciary duty and prudent investment concepts?
http://en.wikipedia.org/wiki/Prudent_man_rule
Prudent Investment state law example
Notice no mention of security lending.
Note originally:
As with any fiduciary relationship, margin accounts and short selling of uncovered securities are also prohibited.
We know that in order to lend out securities in a brokerage account you needed a margin feature and yet today we have institutions lending out stock in volume... what the heck happened to fiduciary duty and prudent investment concepts?
Tuesday, December 27, 2011
institutions discussing security lending
Do you make use of securities lending?
" There are two basic reasons for borrowing: one is to receive a tax advantage on the dividends, which we cannot get, and the other one is to short. "
The managers note 2 motivations of those who borrow... a dividend capture strategy and short selling...
clearly they are aware of the risk to short sellers but re-engage in securities lending regardless.
Note to self.. research this tax thing... If its a tax thing then they are essentially sharing in the tax adv by lending it to those with the adv....
another point has to do with timing the market ...
"But since the financial crisis, demand for borrowing stocks, particularly in order to short, has cooled down although we believe it might pick up again."
so we have recognition that there may be "safer" periods to loan out stock when short sellers aren't behind the borrowing...
surely there could be closer arrangements made between lending securities out and preventing the sales of the securities by the person who borrows it.
By retinkering the contracts one should be able to limit the lending to the tax shelter folks and not the short sellers. I think its a failure of the institutions in not playing a stronger hand " you want my stock you gotta hold it" and setup the infrastructure to enforce it (IE NO CHEATING POSSIBLE).
" There are two basic reasons for borrowing: one is to receive a tax advantage on the dividends, which we cannot get, and the other one is to short. "
The managers note 2 motivations of those who borrow... a dividend capture strategy and short selling...
clearly they are aware of the risk to short sellers but re-engage in securities lending regardless.
Note to self.. research this tax thing... If its a tax thing then they are essentially sharing in the tax adv by lending it to those with the adv....
another point has to do with timing the market ...
"But since the financial crisis, demand for borrowing stocks, particularly in order to short, has cooled down although we believe it might pick up again."
so we have recognition that there may be "safer" periods to loan out stock when short sellers aren't behind the borrowing...
surely there could be closer arrangements made between lending securities out and preventing the sales of the securities by the person who borrows it.
By retinkering the contracts one should be able to limit the lending to the tax shelter folks and not the short sellers. I think its a failure of the institutions in not playing a stronger hand " you want my stock you gotta hold it" and setup the infrastructure to enforce it (IE NO CHEATING POSSIBLE).
The Uptick Rule Returns On Capitol Hill
Lawmaker Calls for Return of 'Uptick' Rule
Couldn't help but notice Charles Schwab advocated this:
"This is a critical and necessary step to reduce volatility and restore investor confidence" Schwab wrote in a letter to lawmakers. "The SEC should move on its own to restore the uptick rule, but if it won't, this legislation will compel the agency to do so."
Sadly I think nothing was done...
uptick wiki (discussion tab good too)
I would say that if one can legally view through another amendment to the investment company acts perhaps that Security Lending would violate a fiduciary duty as well as be legally treated as malfeasance by the custodians and if the brokerages were prevented from pairing margin accounts with lending out stock that we would be miles ahead of any uptick rule...
simply put you would not lend out your house to someone that will destroy it unless you think you will be compensated for that risk... lending fees for securities lending and being allowed to use margin features are not reasonable compensation for the risks of "lending your house on Pacific Heights to Charles Hayes" /lending out your stock marauding short sellers.
Couldn't help but notice Charles Schwab advocated this:
"This is a critical and necessary step to reduce volatility and restore investor confidence" Schwab wrote in a letter to lawmakers. "The SEC should move on its own to restore the uptick rule, but if it won't, this legislation will compel the agency to do so."
Sadly I think nothing was done...
uptick wiki (discussion tab good too)
I would say that if one can legally view through another amendment to the investment company acts perhaps that Security Lending would violate a fiduciary duty as well as be legally treated as malfeasance by the custodians and if the brokerages were prevented from pairing margin accounts with lending out stock that we would be miles ahead of any uptick rule...
simply put you would not lend out your house to someone that will destroy it unless you think you will be compensated for that risk... lending fees for securities lending and being allowed to use margin features are not reasonable compensation for the risks of "lending your house on Pacific Heights to Charles Hayes" /lending out your stock marauding short sellers.
Naked Short Selling and Market Returns
Naked Short Selling and Market Returns
"Our results also suggest that stocks that experience persistent fails are susceptible to short squeezes, as shares move from a normal state where short exposure is established by borrowing and selling to a hard-to-borrow state where fails become a more attractive option for establishing short exposure."
the harder it is to borrow legally...cheating is more common... BIG DUH.
"Contrary to recent claims that naked short sellers are momentum traders who drive down stock prices, we find that returns are typically positive just prior to periods of increased naked short selling that result in persistent fails and that returns generally remain positive for several weeks afterwards."...
but what about the persistent impacts of having increased stock supply after increased demand wanes? I would not have limited my research to immediate impacts (0-2 weeks...)
Well frankly I think short sellers do short into strength and attempt to hold into weakness(or create the weakness with FUD) so this isn't surprising to me...
what about the cycling effects (fail, cover, fail, cover, fail, cover)
"Our results also suggest that stocks that experience persistent fails are susceptible to short squeezes, as shares move from a normal state where short exposure is established by borrowing and selling to a hard-to-borrow state where fails become a more attractive option for establishing short exposure."
the harder it is to borrow legally...cheating is more common... BIG DUH.
"Contrary to recent claims that naked short sellers are momentum traders who drive down stock prices, we find that returns are typically positive just prior to periods of increased naked short selling that result in persistent fails and that returns generally remain positive for several weeks afterwards."...
but what about the persistent impacts of having increased stock supply after increased demand wanes? I would not have limited my research to immediate impacts (0-2 weeks...)
Well frankly I think short sellers do short into strength and attempt to hold into weakness(or create the weakness with FUD) so this isn't surprising to me...
what about the cycling effects (fail, cover, fail, cover, fail, cover)
Short Sale Abuses Killing Shareholders
short overview from the brokerage side of things
Short Sale Abuses Killing Shareholders
"no intelligent investor would ever lend their securities to a short seller"
Read more: http://articles.businessinsider.com/2011-04-19/markets/29971378_1_short-sellers-brokerage-firm-shares#ixzz1hneD95b
much more detail here:
Shorting America
He misses out on Securities Lending entirely. I tend to think the brokerage side of the problem is much smaller than Securities Lending. Both deserve consideration and need fixing.
Short Sale Abuses Killing Shareholders
"no intelligent investor would ever lend their securities to a short seller"
Read more: http://articles.businessinsider.com/2011-04-19/markets/29971378_1_short-sellers-brokerage-firm-shares#ixzz1hneD95b
much more detail here:
Shorting America
He misses out on Securities Lending entirely. I tend to think the brokerage side of the problem is much smaller than Securities Lending. Both deserve consideration and need fixing.
Is Your Fund Pawning Shares at Your Expense?
WSJ's Zweig posted this story:
Is Your Fund Pawning Shares at Your Expense?
cute analogy
"Imagine you hire a real-estate agent to sublet your house. Now imagine he keeps 30% to 50% of the rent for himself. Finally, imagine that the real-estate agent makes you pay for the damages that resulted when the tenants he brought in trashed your house."
Is Your Fund Pawning Shares at Your Expense?
cute analogy
"Imagine you hire a real-estate agent to sublet your house. Now imagine he keeps 30% to 50% of the rent for himself. Finally, imagine that the real-estate agent makes you pay for the damages that resulted when the tenants he brought in trashed your house."
terrible conclusion:
"Your fund should lend out your securities, but the proceeds should go to you. And fund managers should reinvest the collateral only in absolutely safe securities. The current system, where they keep half the gains and stick you with all the risks, has got to go."Why is he in favor of lending at all? His analogy was creative... but didn't go far enough.
In his view the "trashing of the house" was representative of not the short sellers tanking your stock but when the agent firm who lent out your stock and managed the fees collected gets in trouble.
so just to clarify the analogy based on his examples below the quote:
the real estate agent = investment banker
lends house out = lending shares to short sellers
rent is fee collected from short sellers but agent keeps 30-50% of the rent
[Assume typical housing managers collect 10-15% + bonus for finding tenant?]
pay for the damages that resulted when the tenants he brought in trashed your house = the fees were put in an unsafe investment and the fund holder had to pay for the damages instead of the agent???
Um no that doesn't work right as a comparison....
Given his conclusions and examples he should have said:
"Imagine you hire a real-estate agent to sublet your house. Now imagine he keeps 30% to 50% of the rent for himself. Finally, imagine that the real-estate agent makes you pay for the damages when you gave him the fees to "manage" and lost the fees investing in beanie babies."
however I think he really had it right the first time but misdirected us away from the real problem
lets review
"Imagine you hire a real-estate agent to sublet your house. Now imagine he keeps 30% to 50% of the rent for himself. Finally, imagine that the real-estate agent makes you pay for the damages that resulted when the tenants he brought in trashed your house."
Mr. Zweig, you had it right THE paramount fear of a homeowner is the fact your real estate agent willfully rented out your house to the Carter Hayes of Pacific Heights and just like the movie didn't collect a securities deposit to cover the damages from trashing the place.
In addition to paying rent to just live there...when a housing tenant exits there is an exit inspection looking for damages and when found they are subtracted from the security deposit and if the damages exceed the "2 months" deposit then the landlord requests more funds and if they don't get them they can sue for the extra damages.
So what should we consider "damages" in the context of Securities Lending???
How do you demonstrate "harm" in this case? Economics 101 says increasing supply holding demand constant will force prices lower... but how much lower?
How can a fund manager decide if the few basis points he collects for securities lending offsets the impact of increasing the supply of stock and causing prices to go down?
The problem is this is typically seen incrementally..." well whats the big deal if I loan out a few shares... how can that effect the stock price significantly" rather than in aggregate... "what if we all lend out our stock how much could that push prices down?"
I would suggest that the "stack" analysis demonstrates devastation to the stock price.
But what if the tenant of the stock does more than just sell it what if they actively participate in lowering the demand for the house. Imagine if you will renting to a person who spends all his time trash talking the house to his new neighbors.
take for example a well timed negative "investigative journalist" or CNBC appearance piece using Pacific Heights tactics of Fear, Uncertainty, and Distortion to lower demand as the same time you increased the supply of stock... double trouble.
Securities lenders do not appreciate the risks by lending their stock to those motivated to do ANYTHING to lower the price of the assets being lent out.
The paltry fee collected can't possibly offset the hazard of renting out the stock to a " Carter Hayes" or as some would like to call it in the stock world a "Sith Lord". These Sith lords will borrow your stock and eat it for lunch after they are done trashing it for days, weeks, or months there may be little left of your "house" for you to recover after they've moved out.
I don't care if the house was of poor construction it doesn't "deserve" an early demise thanks to Mr. Hayes... it isn't right for your fund(pension, insurance, mutual fund) etc to be collecting trivial fees in exchange for handing your stock over to the bandits to destroy. Please do share with me how there can remotely be a benefit to loaning your house to someone with a vested interest in destroying its value.
Keep in mind without securities lending or the "margin agreement" someone who wanted to bet against a company is limited to an option market (if it exists) and can't directly impact supply of the stock by buying a put. Essentially short sellers are not only betting its going to rain but seeding the clouds by selling the stock and trashing it with FUD.
Taiwan Urges Insurers to Stop Lending Securities for Shorts
http://www.businessweek.com/news/2011-11-27/taiwan-urges-insurers-to-stop-lending-securities-for-shorts.html
Taiwan’s regulators urged insurers to stop lending securities to short sellers ...
“We told the insurers, look, you may gain some fees from lending but it will reduce the overall value of shares. You have to evaluate the cost effectiveness.”
Taiwan’s regulators urged insurers to stop lending securities to short sellers ...
“We told the insurers, look, you may gain some fees from lending but it will reduce the overall value of shares. You have to evaluate the cost effectiveness.”
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