Olivier Le Moal
By Catherine Yoshimoto, Director, Product Management
After years of strong returns, 2022 was the worst year for global equities since the 2008 financial crisis. As bullish sentiments faded, many investors returned to short-selling strategies.
This trend is evident in the recent increase in securities lending activity, the mechanism which enables short selling. In 2022, large institutional investors earned a total of $12.5 billion in securities lending revenues – representing a 15% increase from the previous year.[1] The California Public Employees’ Retirement System (CalPERS) is an example of a large institution that has successfully implemented a long and lend strategy, earning nearly $1 million in securities lending income for the 2021-22 fiscal year.[2]
As more market participants sought to short securities in today’s volatile markets, small cap Russell 2000 ETF liquidity has again given rise to securities lending opportunities that have offered the potential to enhance passive investment returns.
The mechanics of this “long and lend” strategy is illustrated below. As shown, the lender receives cash collateral plus a premium for the duration of the loan. The lender benefits from the premium paid over the value of the ETF, plus any income generated when the collateral is reinvested.
The primary risks associated with this strategy are counterparty and reinvestment risk. However, these risks can be significantly mitigated through conservative investment guidelines, ongoing credit reviews, and marking collateral to market daily.
May I borrow your small caps?
When the Russell 2000 was launched in 1984, it was the first index designed to measure the US small cap market segment. Market participants have since overwhelmingly embraced the Russell 2000 – not only as a benchmark for the small cap market with 92% of US small cap fund products and 83% based on assets benchmarked [3] – but also as the basis for passive investment products such as ETFs.
As such, Russell 2000 ETFs have emerged as powerful tools for shorting or hedging small cap exposures – a process that requires borrowing the ETF. On the other side of this equation, an investor holding the ETF can lend the security to the borrower through a lending agent.
Among these products, ETFs tracking the Russell 2000 have seen exceptionally high liquidity, making them a popular vehicle for shorting the small cap market segment. This presents an opportunity for market participants to potentially enhance passive investment returns with the long and lend strategy – particularly in today’s volatile markets. In December 2022 alone, the iShares Russell 2000 ETF (IWM) was the highest revenue generator among US ETFs, generating $1.64 million in securities lending revenues.[4]
[1] Source: S&P Global Market Intelligence, 2022
[2] Source: CALPERS Annual Comprehensive Financial Report, June 2022
[3] Source: Data as of December 31, 2021 as reported on April 1, 2022 by eVestment for active institutional funds, Morningstar for active retail mutual funds, insurance products, and ETFs, and passive assets directly collected by FTSE Russell. AUM includes blended benchmarks and excludes futures and options. AUM data does not include active and passive assets not reported to a 3rd party source or FTSE Russell. For funds where the AUM was not reported as of December 31, 2021, the previous period AUM was used as an estimate. No assurances are given by FTSE Russell as to the accuracy of the data.
[4] Source: S&P Global Market Intelligence, 2022
© 2023 London Stock Exchange Group plc and its applicable group undertakings (the “LSE Group”). The LSE Group includes (1) FTSE International Limited (“FTSE”), (2) Frank Russell Company (“Russell”), (3) FTSE Global Debt Capital Markets Inc. and FTSE Global Debt Capital Markets Limited (together, “FTSE Canada”), (4) FTSE Fixed Income Europe Limited (“FTSE FI Europe”), (5) FTSE Fixed Income LLC (“FTSE FI”), (6) The Yield Book Inc (“YB”) and (7) Beyond Ratings S.A.S. (“BR”). All rights reserved.
FTSE Russell® is a trading name of FTSE, Russell, FTSE Canada, FTSE FI, FTSE FI Europe, YB and BR. “FTSE®”, “Russell®”, “FTSE Russell®”, “FTSE4Good®”, “ICB®”, “The Yield Book®”, “Beyond Ratings®” and all other trademarks and service marks used herein (whether registered or unregistered) are trademarks and/or service marks owned or licensed by the applicable member of the LSE Group or their respective licensors and are owned, or used under licence, by FTSE, Russell, FTSE Canada, FTSE FI, FTSE FI Europe, YB or BR. FTSE International Limited is authorised and regulated by the Financial Conduct Authority as a benchmark administrator.
All information is provided for information purposes only. All information and data contained in this publication is obtained by the LSE Group, from sources believed by it to be accurate and reliable. Because of the possibility of human and mechanical error as well as other factors, however, such information and data is provided “as is” without warranty of any kind. No member of the LSE Group nor their respective directors, officers, employees, partners or licensors make any claim, prediction, warranty or representation whatsoever, expressly or impliedly, either as to the accuracy, timeliness, completeness, merchantability of any information or of results to be obtained from the use of FTSE Russell products, including but not limited to indexes, data and analytics, or the fitness or suitability of the FTSE Russell products for any particular purpose to which they might be put. Any representation of historical data accessible through FTSE Russell products is provided for information purposes only and is not a reliable indicator of future performance.
No responsibility or liability can be accepted by any member of the LSE Group nor their respective directors, officers, employees, partners or licensors for (a) any loss or damage in whole or in part caused by, resulting from, or relating to any error (negligent or otherwise) or other circumstance involved in procuring, collecting, compiling, interpreting, analysing, editing, transcribing, transmitting, communicating or delivering any such information or data or from use of this document or links to this document or (b) any direct, indirect, special, consequential or incidental damages whatsoever, even if any member of the LSE Group is advised in advance of the possibility of such damages, resulting from the use of, or inability to use, such information.
No member of the LSE Group nor their respective directors, officers, employees, partners or licensors provide investment advice and nothing in this document should be taken as constituting financial or investment advice. No member of the LSE Group nor their respective directors, officers, employees, partners or licensors make any representation regarding the advisability of investing in any asset or whether such investment creates any legal or compliance risks for the investor. A decision to invest in any such asset should not be made in reliance on any information herein. Indexes cannot be invested in directly. Inclusion of an asset in an index is not a recommendation to buy, sell or hold that asset nor confirmation that any particular investor may lawfully buy, sell or hold the asset or an index containing the asset. The general information contained in this publication should not be acted upon without obtaining specific legal, tax, and investment advice from a licensed professional.
Past performance is no guarantee of future results. Charts and graphs are provided for illustrative purposes only. Index returns shown may not represent the results of the actual trading of investable assets. Certain returns shown may reflect back-tested performance. All performance presented prior to the index inception date is back-tested performance. Back-tested performance is not actual performance, but is hypothetical. The back-test calculations are based on the same methodology that was in effect when the index was officially launched. However, back-tested data may reflect the application of the index methodology with the benefit of hindsight, and the historic calculations of an index may change from month to month based on revisions to the underlying economic data used in the calculation of the index.
This document may contain forward-looking assessments. These are based upon a number of assumptions concerning future conditions that ultimately may prove to be inaccurate. Such forward-looking assessments are subject to risks and uncertainties and may be affected by various factors that may cause actual results to differ materially. No member of the LSE Group nor their licensors assume any duty to and do not undertake to update forward-looking assessments.
No part of this information may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without prior written permission of the applicable member of the LSE Group. Use and distribution of the LSE Group data requires a licence from FTSE, Russell, FTSE Canada, FTSE FI, FTSE FI Europe, YB, BR and/or their respective licensors.
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.
Be the first to comment