Securities lending: Trading strategies part IV – Global Macro and High Yield / Distressed Trading

From the desk of Jeroen Bakker

Benelux Consulting Lead, Pierpoint Financial Consulting


In this fourth episode on securities lending trading strategies, I will go deeper into two of the major hedge fund strategies. After the general overview post and the specific SBL trades in episodes II and III the focus now is on Global Macro and High Yield Distressed Trading.

Hedge funds or leveraged institutions almost solely trade these transactions as they require a significant amount of capital and highly skilled analysts.


Global Macro

A global macro hedge fund is typically a fund that holds its investments based on global economic and political views. Holdings may consist of fixed income, equity, currencies and/or commodities. Global Macro investment strategies include analysing trends in interest rates, politics, government policies, and exchange rates.

There are three types of Global Macro trading strategies:

1. Interest rate

Interest rate global macro focuses on the interest rates of sovereign debt (Government bonds) zooming in on monetary policies as well as economic and political situations and forecasts. One of the best-known strategies is around the Eurex Eurobond futures and the cheapest to deliver.

Sample Future contract - the Cheapest to Deliver (CTD) is worth following

From a securities lending perspective, it is essential to understand which bond is the cheapest to deliver against future commitments as that particular issue will be in high demand around the expiration date. The functionality ‘DLV’ in Bloomberg can assist you in this. High demand, in this case, does not necessarily mean higher fees as the liquidity in some of these bonds is very high. However, it will benefit lenders from monitoring the cheapest to deliver one or two weeks prior to the expiration of the Euro bond futures as levels can spike at these times.


2. Currency

This strategy is based on the relative strength of one currency compared to another. Analysts will focus on short term interest rates and monetary policies and use highly leveraged instruments such as futures, FX forwards and swaps, spot transactions and options.

Probably the most famous currency trade was made by George Soros in 1992 when he shorted the British Pound netting him over $1 billion. If you want to learn more, you can watch a YouTube video “How Soros Made a Billion Dollars and Almost Broke Britain”.


Unfortunately for this community, these transactions generally do not have an impact on securities finance.

3. Stock Index

Stock index macro strategies are focused on the index of one particular country often via derivatives such as futures, options and swaps or via Exchange-traded funds. Fund managers try to outperform the index, trading in liquid assets that can easily be offloaded, focusing solely on market risk, meaning credit and liquidity risks are avoided.


These transactions often provide borrowers with supply enabling internalisation rather than borrowing from agents. Key here are two things:

  • Supply in fully weighted indices are more valuable than non-weighted inventory

  • Supply in ETFs, especially in Europe, is still challenging due to multiple different CSDs and lack of inventory. You can find a white paper on ETF secondary market liquidity here that Pierpoint’s partners Roy Zimmerhansl and Andrew Howieson co-authored. Although written in 2012, many of the challenges are still relevant today.

One specific macro strategy evolves around emerging markets and you can read more about emerging markets and securities lending in our recent blog.


Distressed Trading

A distressed hedge fund is often a fund that invests in the debt of a troubled company – usually at a discount – to seek profit if the company turns around. ‘Distressed’ is commonly defined as a significant discount to its fair value. Hedge funds that purchase large quantities of distressed debt often end up with some form of control of the company. Moreover, the distressed debt holders can achieve priority of pay-out in case of an event of default, ahead of equity shareholders or employees. Unlike the other strategies, this is usually a long-only strategy, but of course, it is possible or likely that some shorting activity of the corporate bonds or equities of the company had already occurred, contributing to its discounted price for the debt.

High Yield Bonds

High Yield Bonds differentiate themselves from investment grade as they carry a lower credit rating. Non-investment grade paper usually pays higher interest than investment grade, hence the name ‘High Yield’. Often high yield bonds perform more like equities so a bond-only investor can achieve a degree of portfolio diversification through a combination of government bonds, investment grade and high yield bonds.


From a securities lending perspective, High Yield bond portfolios can be very lucrative as fee levels are often inflated compared to investment-grade corporate bonds. However, keep in mind that liquidity is often low so failed settlements on recalls occur more often than for other securities.


Conclusion

With this fourth episode of securities lending strategies, we conclude the series. I hope you have found it useful and as always, I am more than willing to share additional information if you get in touch with me at jeroen@pierpoint.info


So, what next? In future blogs, I will go into detail on specific actual current or historical securities lending transactions based on M&A, rights issues, convertible bond issues and long-short strategies. So, watch this space.


In the meantime, if you are not sure how to turn this information into revenue for your portfolio, or simply want to speak to an independent advisor, book a free consultation with one of the Pierpoint team.

#securitieslending #hedgefund #bondfutures #arbitrage #beneficialowner #highyield #distressed #derivatives #etfs #index

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Image by Miltiadis Fragkidis

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