Amid a broad sell-off in emerging markets, certain pockets have garnered short-selling interest as hedge funds and other opportunistic managers eye opportunities from the EM rout.
Last month $12.2 billion was pulled out of EM equity funds, while EM exchange-traded funds saw $10 billion in global outflows in January – the largest monthly outflows on record, according to data cited by iShares.
Yet interest in emerging market ETFs has risen among hedge fund short-sellers, according to data provider Markit. The demand to borrow the Vanguard FTSE Emerging Markets ETF has reached a three-year high, with 5% of its outstanding shares on loan as of end-January, while 10% of the iShares MSCI Emerging Markets ETF is on loan.
It was a case of déjà vu from mid-2013, when the US Federal Reserve first announced its intention to taper bond purchases, subsequently unleashing a wide sell-off in EM.
However, there were signs – even if in hindsight – of what was to come as early as October, around the time of the Federal Open Market Committee meeting, when tapering discussions took place.
“We saw a pick-up in the balances [of Asian securities] that were lent, and also saw a pick up in the returns,” says Pierre Mengal, head of securities lending and collateral services for Asia Pacific at Citi.
Since then, lending balances have come down overall, although spreads remain quite high in certain markets, indicating strong demand.
Hong Kong, which is commonly used as a proxy for short-selling China ideas, has seen a rise in spreads although balances have been stable, says Mengal. The indicative demand may be fuelled more by concerns about a possible slowdown in mainland economic growth, rather than tapering, he adds.
In Japan, spreads have jumped by about 20 basis points since October, says Mengal. The stock market had foreign-led net outflows of just over ¥1 trillion ($9.75 billion) in January – the highest monthly level since August 2011, according to Ministry of Finance data.
Anticipation around year-end dividend announcements and an expected fall in equity prices following last year’s bull market rallies in Japan were likely factors leading to the build-up in spreads, says Mengal.
Tobias Hekster, principal of global volatility arbitrage strategy True Partner Fund, views emerging markets as a group of flashpoints that were ignited with the onset of tapering.
“We have had scrimmages in Thailand for quite some time and the problems in Turkey are not necessarily new. Argentina, if you look at it, was a slow-motion trainwreck for months,” says Hekster.
“A lot of [emerging markets] have a balance of payment problem, government debt problem and growth that’s somewhat disappointing.”
Hekster expects that 2014 will be a “relatively volatile” year for trading. However, as with the start of the sell-off in January, it’s difficult to see what events might act as a trigger.
“The markets are very much psychologically driven,” says Hekster. “There’s so much human behaviour in place that when everyone says it’s safe to swim, that’s usually when the sharks are out.”
His sentiments were echoed by Mengal. “It’s a psychological effect. It’s a reversal of a trend of injecting liquidity [into emerging markets] for the last five years” since the crisis.