Let the games begin!
Standard & Poor's long-awaited decision late Tuesday on which income trusts will join Canada's benchmark index has kicked off a flurry of speculative trading.
In this corner, the Street's professional traders -- hedge funds and investment dealers -- are loading up on trusts, anticipating a quick score by selling to the index fund crowd when they are forced to go on a buying binge.
Facing off against the pros are the so-called passive investors -- the likes of State Street, Barclays Global Investors and Ontario Teachers. These are some of the biggest asset managers and savviest traders on the planet, and they're primed for a fight.
It will climax late tomorrow with the largest rebalancing of stocks in the Toronto Stock Exchange's history.
It promises to be quite a show, as $1.2-billion in trusts change hands, and some of the best minds in the market go head-to-head.
The revamped S&P/TSX composite index will welcome 72 trusts as new members when the market closes tomorrow. The moment these trusts join the club, index funds that strive to replicate the benchmark's return will need to own them.
Traffic is expected to be so heavy that the TSX has temporarily loosened the rules on end-of-day trading to help everyone get their orders filled.
There is expected to be $1.2-billion of trusts snapped up, with volumes of anywhere from 300,000 units of Mullen Group to 5.9 million of Yellow Pages.
And only half the trust weighting is being added to the S&P/TSX composite index this week. We'll do this all over again in March.
Prices for the 72 trusts that made the grade this time are already rising to reflect the hedge fund buying. TD Newcrest published a report yesterday estimating the hedge funds are now pregnant with $500-million worth of trusts, all of which they intend to deliver to the index types at the end of the week. (This, of course, would be the same pro-trading crowd that made a fortune two weeks ago by snapping up dividend-paying stocks and trusts a few hours ahead of Finance Minister Ralph Goodale's market-friendly announcements.)
So are the index funds walking blindly into tomorrow's session, oblivious to the fact that the rest of the Street has loaded up on trusts and is waiting to take advantage of their orders? Hardly.
Top-tier passive investors are taking steps to avoid being gouged. One simple precaution is to do what the hedge funds are doing, and buy ahead of tomorrow's deadline.
Several traders report the index funds are already snapping up trusts, and estimate that up to half the passive buying may be done before the TSX sets its final prices tomorrow.
TD Newcrest index analyst Peter Haynes yesterday cautioned the hedge fund crowd to avoid being greedy, and to start taking profits on trust holdings.
But even if a few passive funds are already making moves, there is still going to be enormous demand for trusts that gets satisfied at tomorrow's closing price, in the window for trading that the TSX holds open at the end of each session.
Index fund managers get fired if they don't accurately track a benchmark. Many prefer the certainty of buying at tomorrow's close, no matter how distorted the price, over the market risk that comes with buying early.
The fun doesn't stop with trusts. As the index funds prepare to add trusts to their portfolios, they are creating waves.
"Recall that indexers need cash to pay for income trusts and will raise the necessary proceeds by selling the large, liquid names," Mr. Haynes said in a note. He's calling for $500-million worth of selling in liquid S&P/TSX stocks, such as banks, insurers, and major energy companies.
Adding trusts to the S&P/TSX index will also increase pension fund interest in the sector. These funds represent more than $500-billion in assets. They've only recently rolled out the welcome mat for trusts. These funds are expected to add 10 or 12 favourite trust holdings to their Canadian portfolios.
The fact that the Street is going at it over trusts is a development that investors should welcome. The sector deserves inclusion in this benchmark index. Everyone is focused on tomorrow's rebalancing because S&P has done exactly what it said it would do, so the process has been transparent.
The ratings agency stuck to its guns by insisting trusts join the benchmark even after the Finance Department raised doubts about the sector's future by launching a under review. By announcing the names of the companies that will be joining the index, S&P has given everyone time to plan. Now the pros will duke it out to see who profits as the trusts come of age.
© The Globe and Mail
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