(an excerpt from Valor Economico article written by Teo Takar)

In today’s bear market, borrowing stocks is increasingly becoming more common at brokerages’ trading desks. The financial volume of this type of transaction tripled in the last four years and continues growing at a fast pace. Whereas the leading stocks on the Brazilian market seem to be in free fall, and interest rates of fixed-income investments are also less attractive, investors seek strategies that, if not providing big gains, can at least protect their assets.

For at least three years the Ibovespa, São Paulo Stock Exchange’s benchmark index, has not been reason for joy to investors. Its latest big gain was in 2009, when it rose 82.6%. Since then, it accumulates a 17% loss. This year alone, the decline up to last Thursday was 7.9%.

“The market’s volatility and the scenario of low interest rates generate opportunities for short trades,” says Arnaldo Puccinelli, a fixed-income specialist at Planner Corretora. “The market is very nervous, especially with the government interventions in some sectors and the uncertainties on monetary policy. Investors have preferred to be short, awaiting news.”

Stock borrowing rose to R$785.9 billion in 2012 from R$258.9 billion in 2009, a 203% growth, according to BM&FBovespa data. This expansion was at a much faster pace than the overall trading volume. In the last four years, the trading volume grew 39%, to R$1.69 trillion in trades in 2012. In January, borrowing raised another 18.5% over December 2012.

Some recent events contributed to the rise in demand for stock borrowing, with some stocks having borrowing rates of over 20% a year, a return that is nearly three times the current base interest rate, Selic, of 7.25%. “Stock borrowing of power companies took off since the middle of last year, because of talks on concession renewals and rate changes,” says Marcos Nogueira Ramos, chief of the stock-borrowing desk at Fator Corretora.

Borrowing of shares in the “X companies” controlled by Eike Batista is also on the rise. “We have shorted the group’s stocks quite often,” Mr. Ramos says. “OGX, MMX and other Eike stocks have been suffering for some time with a series of negative news on the group.” OGX common shares were posting this year up to Thursday a decline of 27%, whereas those in MMX had lost 30%. On Thursday, shares in OGX rose 12% after Valor informed that Mr. Batista was negotiating the sale of a stake in the company to Malaysia’s Petronas.

BM&FBovespa data also show that mutual funds are the biggest borrowers and have been increasing their share in this segment. In December, they accounted for 70.5% of all borrowed shares. They are followed for foreign investors, with a little over 20% of borrowed shares. Individuals still have a small presence in this particular market, of nearly 3% of its total volume.

On the other side, the story is different. Funds account for 27% of the volume of shares put for lending, whereas foreigners account for 36% and individuals, for 32.8%. Traders say retail investors are less willing to “short sell,” given its biggest risk, and prefer to act as lender, a way of improving portfolio returns, especially in times of market weakness.

“A short sale is still a trade for more experienced investors. Those who are beginning on the market and want to operate in the lending market usually starts as lender. But we have products at the brokerage for those willing to build a short position,” says Rafael Nogueira, member of the stock lending team of UM Investimentos.

Seeking to tap that potential, UM has specialized in this segment, offering trading tools and  permanent covering of lending moves. The brokerage periodically releases a suggested portfolio of stocks to be shortened — meaning investors bet on their fall.

“We’ve realized borrowing stopped being only a tool that provides liquidity to the market and has become a niche with potential for several trades.” Both Mr. Nogueira, with UM, and Mr. Ramos, with Fator, rarely get trading orders directly from small investors. In general trades are closed with autonomous agents — professionals who represent and advise individuals — fund managers or institutional investors.

BM&FBovespa is also paying attention to the expansion in stock borrowing and already preparing improvements to its Securities Bank (BTC) platform. “We’re improving the system’s user interface. It will become easier for investors to follow borrowing moves,” says Julio Ziegelmann, head of equities at BM&FBovespa. He says the new structure is likely to go online within a year, together with the unification of clearing houses, the exchange’s systems of risk control and custody.

Source: Valor

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