There is an old rule of debate that when you want to “prove” your case, pick out examples that work for you and ignore those that do not. The Association of Superannuation Funds of Australia is teetering on the edge of that practice over the issue of super funds loaning stock.
Mathematically it is correct in saying that if superannuation funds lend stock to shorters and the funds receive a fee, it therefore boosts returns. But if that stock lending exercise inadvertently or deliberately becomes a part of a coordinated bear raid that then decimates the share price of the target company, the fund members suffer greatly. And if the bear raid on an individual stock were to bring the whole market down, then the client suffering extends far beyond any fees that might be received.
Before looking at the individual examples that illustrate where stock lending devastates superannuation returns, it’s important to set out where it is absolutely harmless and in fact helps the market.
There are a variety of derivative positions, almost always in large companies, that help investors reduce risks. Part of them involves a degree of shorting that is arranged via stock lending. There is absolutely nothing wrong with this practice and indeed in 99% of the cases everyone wins. The trouble is that this legitimate practice has been prostituted.
Similarly, margin lending is an integral part of the long term sharemarket, but in the Opes and Tricom situations it too was prostituted. When an industry can’t look after itself, regulators move in. We need to underline that superannuation funds are only part of the stock lending industry – index funds and overseas/local investors are key parts of the game.
We have seen five big recent bear raids – Bendigo Bank, Challenger, Centro, Allco and ABC Learning. In the case of ABC, Centro and Allco, there was a fundamental weakness in the company that the bear raiders had discovered. They pummelled the stocks and major changes were required in the business models. The superannuation funds would have been better advised to sell the stock rather than lend it and see their returns splattered.
It is the Challenger and Bendigo Bank raids – which don’t appear to have been at the top of the superannuation funds’ study list – that offer the biggest lessons. Neither company had a basic weakness, so the routine technique used by the shorters of circulating rumours every day this time involved spreading total falsehoods. Challenger CEO Mike Tilley says about 70 false rumours were being spread every day as the hedge funds borrowed stock and shorted for all they were worth. Confidence in the Challenger company has been shattered, and it has stayed on a much lower price-to-earnings ratio.
In the case of Bendigo Bank some 14.5% of the stock was loaned to the shorters, and the Challenger techniques were used to decimate the share price. They would have led to a run on the bank but for the fact that CEO Rod Hunt had Bendigo in great shape and a French bank began buying stock. The shares recovered dramatically.
But the Challenger bear raid led to the collapse of Opes and the damage that has caused to ANZ. All those superannuation funds who participated in the exercise lost big sums for their clients. And if the Bendigo bear raid had been successful, and the hedge funds and their superannuation/index fund backers had won, we would have seen a huge fall in the overall market where everyone would have suffered.
I think the answer lies in the current stock lending disclosure situations being greatly expanded so that stock lending becomes very transparent. When a super fund loans a stock outside the top 50 stocks, it may need to gain approval. What we should try and do is to protect the stock lending of the BHPs of the world, which help the derivatives market, but regulate the stock lending that leads to bear raids on middle ranking companies, which can devastate the interests of superannuation fund and index fund members.
This story first appeared in Business Spectator.