Tag Archives: elections

Read This Before Shorting Anything!

Summary Shorting mechanics are a bit more complicated than just betting on a price decrease of a specific security. Short sellers should be aware they are responsible for all payments from that security. If you want to be a holder of record, make sure you aren’t lending out your security. Shorting stocks has the potential of unlimited losses unlike shorting bonds. There are some tactics to shorting and securities lending that may be helpful to know. Shorting is a helpful investment method to protect any portfolio from market downturns or to even take a view on an individual company but it’s something that’s a bit more complicated than just betting on a security’s price decline that investors should be aware of before trading. Here’s a look into it a big further. The basics: Short selling is betting on a price decline of a specific security whether it be a stock or bond. If a person cares to short a stock or bond, he or she will need to borrow the security from a lender, give them an IOU, and sell the security in the market. No person would lend out their securities for free, so the short seller needs to compensate the lender for lending them their securities by paying them a fee (borrow rate). The lender lends their securities, gets an IOU from the lendee to return it to them eventually, and receives a fee for allowing the lendee to borrow them. Just conceptually, if I was a lender who wasn’t getting paid for lending out my securities to a short seller, I am essentially letting a person bet against a security that I’m long for free which is obviously a conflict in investment interests. This fee is determined by the liquidity of the securities lending pool (which is different than the liquidity of the security) and the demand to short those securities. Usually a prime broker will tell you the securities lending availability by checking their “feeds” which tells them different advertisements of size and fees being offered from different sources around the Street. The difference between the liquidity of the security versus the liquidity of the security lending pool is that not all securities are available to be lent out for a myriad of reasons. One cannot judge a security’s borrow availability by how much it trades in the markets. You can think of what the fee will be by supply and demand rationale. If there are a lot of securities available to be lent out, then the fee is low, as you can borrow the securities from a lot of available sources, which creates competition to have the lowest fee (large supply, low demand). If there is a small amount of securities in the lending market and a lot of short sellers wanting those securities, then the fee will be high (small supply, high demand). One needs to borrow the securities before short selling to prevent “naked short selling,” meaning you don’t have the underlying securities to sell. This prevents artificial securities from entering the market and also if a short seller sells me a security without borrowing it, what do I own then? This obviously creates chaos and could cause wild market swings (if I had unlimited capital and could naked short sell, I could just keep selling until I clear out all the bids and depress the security to unjustifiable levels). Let’s explore a bit further: I want to short a stock. I borrow it from person A, give them an IOU, and pay a small fee to them in order to compensate them for lending me the stock. I then sell the stock in the market to person B. Now the stock unexpectedly has a vote and all the holders of record can submit their elections. Who is the holder of record? Who is entitled to vote? Person A or person B? Well the answer is person B. I sold the stock I borrowed from person A to them. The stock settled in person B’s name. Now let’s say the stock pays a dividend. Who gets the dividend payment? Person A or person B? Well person B does from the company, but me, as the short seller, needs to compensate person A for that company dividend and pay it to them. If you need to be the holder of record, make sure your stock isn’t being lent out by your broker. This typically isn’t the case unless you bought the stock on margin. If that is the case, typically you can move your stock into a fully paid cash account in order to be the recorded holder. Always remember, if you are a short seller, you are responsible for all payments and/or coupons/dividends from the security to the original holder you borrowed it from. An example of this, I borrowed a stock from person A for a fee of 1% per year. I short sell this stock to person B in the market at a price of $100. Over the course of the year, the stock paid a $4 dividend and dropped to a price of $95. I decide to close out my position. I buy the stock and deliver it to person A covering my short position and canceling my IOU. It may look like I made $5 because of the difference in price from where I shorted it to where I covered it, but I had to pay a $4 dividend to person A (the $4 dividend was paid to person B from the company) and also pay them a 1% annual fee, which equated to $1 over the course of the year. So I made ($100 – $95) – $4 dividend – $1 fee which equals $0. Also, a little bit more complicated is that you may earn money by borrowing a security by getting a “rebate.” Basically, the money you earn on your short sale proceeds (the money you take in from short selling the security) is greater than the fee you need to pay to borrow the security. But for the most part, investors should figure they need to pay a fee to borrow a security. Even further: The short seller is responsible for the borrow fee and any payments the security may pay out including dividends and coupons. Most short sellers are wary about short selling a stock with a regular high dividend unless they are confident the dividend will be cut or suspended. If the dividend is cut, that infers the dividend yield is less and the stock price will drop to compensate. The same idea applies to bonds. The short seller has to pay the interest coupon to the person that lent them the bond. The person who bought the bond from the short seller is the holder of record and receives the coupon from the company. Risks: Now the risks involved with shorting is something everyone should be aware of. Shorting stocks isn’t for the tepid because unlike being long a stock, your losses aren’t limited. For example, I bought a company’s stock at $10 (I’m long). The most I could lose is -$10 if the company goes bankrupt and goes to $0. So if you are long anything, your ultimate loss is the security ends up worthless and you lose all your invested money. There isn’t a case where the security will have negative value and you will end up owing money. So your risk is capped to a certain point. But with shorting a stock, this is not the case. Your losses are potentially uncapped. For example, I shorted that same stock at $10. The stock then doubles and I lost -$10. The stock triples and I now end up losing -$20. The stock then rallies to $100 and I now lost -$90. The upper bound of where a stock can go is uncapped. There’s no end limit to where a stock can appreciate. Obviously, one can assume a stock bound won’t be infinity because investors would realize it’s trading at insane multiples and would start to sell, but there is no cap to losses like you have being long a stock. Investors can lose more money than they put in. But unlike shorting stocks, there is a cap to losses when shorting bonds. To oversimplify, if I’m short a bond at $99, the most I can lose minus whatever I need to pay for coupons and borrow fees is $1 when the bond goes to par when it matures. Obviously, there are cases where the bond trades above par depending on rates and yields but for simplistic sake, a bond cannot mature above par so that caps a short seller’s losses to a point. Stocks vs. Bonds: As shown above, one might prefer shorting bonds over stocks because you are capped to how much you can lose when shorting a bond that you don’t have when shorting a stock. I certainly feel more comfortable with the cap to how much I could potentially lose. But with that said, you really have to be comfortable with the deteriorating credit quality of a company or sovereign to short a bond. As stated in another article , credit gets paid before the equity holders and is less likely to be impaired due to the capital structure. So if there is real financial trouble, the stock will drop before the credit is feared to be impaired. And if the credit is going to be impaired, the stock is most likely 0. If you want to short a stock but don’t want to have your losses uncapped, then there is always put options, which will do that for you. You are short at a certain price and only risk the premium you paid to buy the put option. What else could go wrong while shorting? Most of the time, just because you borrowed a security from a lender and gave them an IOU doesn’t mean they can’t ask for that security back at any time they please unless you two entered into a term borrow agreement (agreement to borrow the security for a specific amount of time without the risk of being called back from the lender but since the lender is locked in to letting the short seller borrow the security for a specific amount of time they ask for a higher fee) which isn’t common in the lending markets but I have used them before. So if the lender wants the security back and you aren’t ready to cover your short, you have 2 options: Find another lender willing to lend you the securities and deliver it to the first person wanting their securities back and now be short with the new lender. Buy the security in the market to close out your short position prematurely and deliver it back to the lender. If all the lenders at the same time request their securities back, this can cause a “short squeeze,” where all the short sellers have to buy the securities back in the market to cover their short positions artificially inflating the security’s price. Sometimes a large holder of the stock will move their position from a margin account to a cash account in order to cause this (there’s no rule saying you have to lend out your stock if you are a large holder but is generally frowned upon when it causes a wild stock fluctuation). There are other tactics people use when trying to secure borrow, one I mentioned here which can cause a real short seller to show up as a top long holder from their filings. The holder is both long and short the stock to create a riskless “box” position. They sell the long part of the box when the stock appreciates to the price they want to be short at making the holder essentially get short at that level. This just ensures that the short seller has the borrow for hard lending names when they want it and don’t need to find a locate when the stock gets to the level they want to be short at. The filings only show their long position (not their net long and short combined positions) which will make them show up as a top holder of the stock implying they have a long thesis, which they might not have. Long story short, don’t always believe 13-f filings. Conclusion: It’s true, over the long run, the stock market appreciates. But if you listen to Warren Buffett : “Rule Number 1: Never lose money. Rule Number 2: Never forget rule Number 1.” Then you’ve got to use shorting to protect capital during any downturns, periods of volatility, or to hedge your positions, but there are inherent costs and risks associated with it that not all investors are aware of. A balanced portfolio should have a little short percentage to either hedge current positions or to just protect from market fluctuations. Some people are inherently against shorting because you are betting against companies, but shorting does have its advantages. It increases stock market liquidity and can weed out some bad companies and/or outright frauds if used in the idealistic fashion and not just for short-term profits. Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Sri Lanka – Do The Elections Represent A Green Or Red Light To Investors?

Summary 2-term President Rajapksa loses despite calling election 2 years early. President Sirisena calls for National Government in ‘Rainbow Coalition’. China’s Economic Influsence likely to be reduced, but any shortfall likely to be made up from elsewhere. India likely to play a more prominent role in economic activity. The election is a milestone in Sri Lanka’s maturing democracy and may well represent a milestone in its economic progression. Background On Thursday January 8th 2015, Sri Lanka went to the polls in a Presidential election. This election had been called 2 years early by President Rajapaksa following evidence of declining support for a President that had once been hailed as a national hero . Indeed, his party’s previous dominance had allowed him to change the constitution and permit his seeking a third term. However, despite this wavering support, few expected him to actually lose the election. In the event, Maithripala Sirisena, a former health minister in Mr. Rajapaksa’s cabinet, won the election and was immediately installed as President. Whilst polls had shown the 2 candidates to be level pegging, this result remained shocking. It is thus necessary to consider whether this is evidence of a maturity in Sri Lankan politics or a dangerous change of course following a period of solid economic advance. The Election Despite rumors that elements of the police and army were intimidating anti-Government supporters prior to the election, the poll went ahead in a relatively peaceful fashion. Around lunchtime on the 9th, President Rajapaksa conceded defeat and left the Presidential Residence. That evening, President Sirisena was inaugurated as President and congratulations poured in on a smooth transition from the country’s neighbours and indeed from US Secretary of State Kerry . However, on January 11th, news emerged that the transition may not have been as smooth after all. An aide to President Sirisena announced that President Rajapaksa had approached the police and military seeking support to remain in office. An attempted coup was claimed . However, even if this is correct, the police and military refused to support Mr. Rajapaksa and a peaceful transition has been effected. It seems highly unlikely that Mr. Rajapaksa will make any further attempt to unseat his successor following his rejection by the security forces. Moreover, it is likely that this initiative will be used by President Sirisena and his supporters led by the United National Party (‘UNP’), as a way of pressuring Mr. Rajapaksa’s Sri Lankan Freedom Party (‘SLFP’) ahead of April’s parliamentary elections. From this perspective, it seems likely that the Rajapaksa family’s dominance of Sri Lankan politics (and indeed business life) is at an end. Winners and Losers The principle losers from this election are the Rajapaksa family and China. It was no secret that members of the Rajapaksa family had benefited from their family connection to the President. Whether by holding official office or by their involvement in business deals, the ‘first family’ had clearly benefited. One of the first questions private equity or strategic investors made was which part of the family would be involved and what their expectations would be. Their involvement in the country’s business life cannot be removed overnight. A comparison may be made with some of the business associates of President Suharto of Indonesia whose influence certainly waned following his removal from office, but didn’t disappear. However, it is equally clear that Mr. Rajapaksa’s loss was at least partially owing to discontent with the nepotism that had marked his rule. Many of the transactions in which they had been involved were with Chinese investors . Indeed, a simple overview of Sri Lanka’s international relations during President Rajapaksa’s rule involves China supplying the armaments and finance required to extinguish the LTTE and in return being given a prominent role in the country’s economic expansion. Whilst this certainly involved providing access to money and equipment that has propelled the rebuilding of Sri Lanka’s infrastructure at a rapid rate, critics pointed to the Chinese investment as being a quid pro quo for securing a naval base in the Indian Ocean. Such Chinese involvement naturally put pressure on Sri Lanka’s relationship with neighbouring India. President Sirisena has already talked about China being a good friend to Sri Lanka but warned about not being behoven to any one nation. Additionally, his election manifesto included the cancellation of the Colombo Port City project, a US$1.3 billion project to reclaim land and build everything from high rise offices and apartments to a Formula 1 Grand Prix track. If he carries out these promises, it is clear to annoy China on both economic and strategic grounds. Indeed some have hailed the defeat of President Rajapaksa as destroying China’s overall Indian Ocean Foreign Policy and placing a dent in its ambitions to build a global network of ports. This is likely to be exaggerating things a little, at least at this stage. It is easy to point to India as being the strategic winner from this election. It understandably held concerns about China’s influence both economically and militarily in Sri Lanka. Additionally, the economic policies of the ruling BJP are more in line with the UNP in Sri Lanka than they were with the more left wing Rajapaksa administration. Additionally, the religious minorities of Sri Lanka were solidly behind President Sirisena, and polls indicate that the size of their turn out was a major influence in his victory. Whilst President Sirisena and his key supporters are Sinhalese, it is likely that their policies will be more accommodative of minorities than had been the case with the previous administration. Hence his call for a ‘rainbow coalition’ Invest or Wait? Let’s consider the key questions at this time: · Will President Sirisena change economic course in Sri Lanka to the detriment of investors? o Highly unlikely. His key supporters (UNP) have a more pro-business posture than the SLFP and have been critical of policies (such as the land reform bill) that were deterring to foreign investors. · What will the impact be of cancelling the Colombo Port City project and the planned integrated resorts (casinos)? o The Port City was certainly a massive project and the construction and engineering would certainly have added to the local economy. However, there were major doubts about its ambition and viability. o Given recent revenue contraction in casinos from Macau to Singapore and the planned launch of casino based projects in many other East Asian countries, it is questionable whether building such projects in Colombo would have had a big impact on tourist arrivals and expenditure. Sri Lanka has a wealth of attractions for tourists and many would argue that it can continue to accelerate its tourism industry without resorting to gambling. · Are the upcoming Parliamentary Elections important? o President Sirisena has pledged to reverse the trend of increasingly centralized Presidential power that evolved during President Rajakasa’s terms and strengthen parliament. However, this may be the largest uncertainty given the composition of the coalition which supported his candidacy. o There is little doubt that this coalition was more ‘anti-Rajapaksa’ than it was ‘pro-Sirisena’. Equally, that Sirisena comes from the left-leaning SLFP but now is supported by the right-leaning UNP creates uncertainty. He talks of a “rainbow cabinet’ but this may turn out to be a more effective sound bite with echoes of Mandela than a sustainable coming together of previous enemies. o President Sirisena now has 3 months during which he must bring together elements of multiple parties into a coalition which will support him and demonstrate leadership prior to the election. This will require an impressive level of political maneuvering and only time will tell whether he can pull this off to create a balanced but effective government. The worst case scenario is for the coalition to fracture and leave him without a power base. o His Prime Minister, Ranil Wickremsinghe, was the driving force behind the selection of Mr. Sirisena and is the leader of the UNP. The day to day relationship between these two gentlemen is going to be critical as if Sirisena is regarded as being a puppet of the UNP, then the coalition could fracture rather easily. · Should we be concerned about China being annoyed? o In a word…’No’. Whilst there is little doubt that a return of Rajapaksa would have been China’s preference, they will not want to endanger their access to this strategically important island. Whilst the military benefits of Sri Lanka were often focused upon, the economic benefits of having a trans-shipment option that is lower cost and arguably more convenient to Singapore or Malaysia is also key to Chinese interests. o As mentioned above, this may also allow India and Sri Lanka to become friendlier, particularly given the friendship of Messrs Modi and Wickremsinghe. It would be no surprise if Mr. Modi was one of the first visitors to Sri Lanka, bringing with him promises of additional trade and support. · What about the response of other Countries? o The removal of Mr. Rajapaksa who was the architect of the crushing of the Tamils may bring Sri Lanka closer to its Commonwealth brethren as well as the US. This may well translate directly into expanded financial support as well as giving the country the ability to face the events that accompanied the ending of the civil war without being punished for retaining as President the architect of these events. o It is likely that international relations will improve under Mr. Sirisena and Sri Lanka may once again focus on promoting its many strengths rather than defend its recent history. Conclusion Whilst there are reasonable uncertainties about President Sirisena’s political leadership and his ability to build a sustainable coalition, the positives from this election exceed the doubts. International investment will be more balanced and strategic investors are less likely to be frozen out by preference for ‘first family’ initiatives or Chinese investment. Despite this, credit has to be given to President Rajapaksa for the great strides that Sri Lanka has made over recent years. The country now has a solid foundation of infrastructure including power generation and transportation from which it can build. In m y previous article , I argued that there were many reasons to be positive about Sri Lanka over the coming decade. I see no reason for concern that these reasons have been diluted and indeed believe that stronger growth can now be achieved. Today, Pope Francis arrives in Sri Lanka on an official Papal visit. The timing is appropriate as he will be being greeted by a President who has made reconciliation between religions a key issue. From this perspective, it is an effective ‘Christening’ of the new administration. Only time will tell whether President Sirisena will reward the electorate’s confidence, but the signs are positive and assuming that he can harness the spirit of co-operation and renewal that Pope Francis is certain to preach, the country is set for strong further growth. Investment options for prospective investors in Sri Lanka remain limited. The Ceylon Stock Exchange is small, illiquid and volatile. In essence, it is more of a private equity market for the time being. However, we believe that this will change over coming months as Sri Lanka focused investment vehicles emerge. To this end, emerging market investors should keep at least one eye on Sri Lanka given its strong potential.