Stock lending and fiduciary duty
Posted by Christie Malry on September 28, 2011 at 8:34 pm
Ritchie gets riled by the brilliantly named @ssap9rulesok into spluttering the following:
Well, I happen to be an FCA too. And Ritchie is wrong. Here's why.
Just suppose you're a pension fund manager and you believe that a particular share of yours is overpriced, meaning that its price is set to fall. What would you do? Of course, you would sell it.
And suppose that you believe that that share is underpriced, meaning that its price is set to increase in the medium to long term. What would you do? Of course, you would hold it.
Now suppose that some fool comes along and offers to pay you to lend them that stock. You will get your stock back of course, and you will also get some cash for letting them borrow it. Clearly you think the share is underpriced, otherwise you would have already sold it. So, not only do you get to keep your share, you get some cash too. It's the ultimate example of having your cake and eating it.
So any self-respecting pension fund would happily take the money of anyone who wished to pay them to lend out their stock. Why not? If you think the shares will, in the long run, increase in value you've got nothing to lose and everything to gain. Stock lending is not only consistent with good fiduciary duty, it's virtually required by it.
OK, I get this entirely. And agree with the theory.
However, is there an argument that if someone is offering you this deal then, knowing that people who short-sell tend to make money (I'm assuming, there, is there any data either way?), and that the very fact that a share becomes a short sellers target can devalue it out of line with any rational view, you might be advised to ask 'what does this guy know that I don't'?
Now, I guess we must then consider our long-term objectives. The market value on a share doesn't (well, shouldn't) make a damn bit of difference to the actual value. So if you're holding a share for the long term, then the 'theory' you explain holds better. Tread carefully, mind, because a falsely undervalued stock can lead to corporate actions (e.g. a takeover, ill-advised change of management, panic decisions etc) which risk reducing the real value as well as the imaginary one.
Perhaps another thought you may have is that if your share is a target for short-selling then, assuming you're not in a position to sell your holding (which if, say, you're a pension fund holding a fat chunk of a major bank, you probably can't) then do you decide that what will be will be, and you may as well take the cash on the table and try and buy yourself a hedge?
(I'm not all that knowledgable about this at all.. but if someone offered to pay me to borrow my shares my thought process would go beyond a simple 'wahey, show me the money'.)
Whilst short sellers may make money overall (don't know; I've never seen any figures), I suspect they often get individual trades wrong. So the fact that a shorter asks to borrow stock doesn't mean that it's about to go down.