An unexpected rise in the cost of equity financing is pressuring some hedge funds and asset managers, while presenting a lucrative opportunity for cash-rich investors, according to a report by Bloomberg.
The financing spreads on S&P 500 Index futures – embedded costs that allow investors to gain stock exposure without purchasing shares outright – have surged in recent months. After hitting record highs late last year, these costs remain above historical norms, even as markets have experienced recent turbulence.
Hedge funds often rely on futures to maintain market exposure while preserving capital. Instead of buying stocks outright, they use leverage, paying a financing spread on top of a risk-free interest rate. As more firms have piled into these trades, competition has driven up spreads, increasing financing costs for money managers.
“The dislocation is very large compared to the spread’s historical range, and the S&P 500 is one of the most canonical, most liquid markets in the world,” said Ashwin Thapar, head of multi-asset class investing at DE Shaw Investment Management.
Despite the S&P 500’s recent correction, which typically alleviates funding pressure, spreads have remained elevated. According to JPMorgan, the three-month implied financing spread on S&P 500 futures has fallen from December’s peak of 1.8% to about 0.6%, yet this remains in the top quintile of the past five years. Long-term financing costs remain stubbornly high.
For institutional investors with available capital, such as pension funds and sovereign wealth funds, these elevated financing spreads offer attractive returns. Firms like Janus Henderson are capitalising on this by engaging in cash-and-carry arbitrage – buying S&P 500 stocks while selling futures contracts against them.
“The pickup of equity financing spreads makes this trade extremely attractive right now,” said Natasha Sibley, a manager on Janus Henderson’s multi-strategy team.
Other hedge funds, lacking the same balance sheet capacity, are turning to alternative plays like trading calendar spreads – betting on changes in financing costs over different maturities. Demand has surged for CME’s Adjusted Interest Rate (AIR) Total Return Futures, with open interest in the product exceeding $255 billion this year.
The persistence of high financing costs suggests a structural shift in equity markets. Regulatory constraints on bank balance sheets limit their ability to provide financing, creating a supply-demand mismatch. As a result, hedge funds must navigate an environment where leverage is more expensive, while large institutional investors stand to benefit.
However, some market participants believe this trend may be temporary. Pete Hecht, head of the North America portfolio solutions group at AQR Capital Management, noted that surging demand for S&P 500 products last year fuelled higher financing costs. With stock market exuberance cooling in 2024, spreads could normalise over time.
