For a few years now, the song has remained essentially the same for owners of institutional assets and the managers they partner with – the pressure on costs keeps them squeezing, and with high valuations and low returns, respond to performance expectations is a more elusive and elusive goal. to achieve. To potentially increase portfolio performance and offset some costs of ownership, investors and managers have turned to perhaps the most versatile tool they can take advantage of: exchange-traded funds (ETFs) and the potential benefits. the securities lending they can offer.
How securities lending works and transaction mechanisms
Securities lending is a well-established practice in which an investor who owns a security temporarily lends it to a borrower in exchange for a commission. The lender retains all economic interests in the security and therefore remains exposed to the performance of the security throughout the life of the loan. As the transfer of ownership is temporary, the securities may be returned by the borrower or recalled by the lender at any time.
The loan is initiated when a borrower, usually a large financial institution, engages with a loan officer, who acts on behalf of the lender. Borrowers look for a multitude of securities from the loan officer, including individual stocks and bonds held in ETFs as well as units of an ETF itself. In exchange for the borrowed securities, the borrower submits collateral to the lending agent. This collateral exceeds the market value of the loan, with a daily market valuation process during the life of the loan. In addition, the borrower is required to pay all distributions on the securities (dividends or interest payments) that occur during the term of the loan to the lending agent.
ETF investors can potentially benefit from two levels of securities lending: (1) underlying individual securities lending – which is initiated and managed by the ETF provider and reflected in the performance of the ETF. (2) the loan from the ETF itself. By choosing to lend the ETF itself, investors can potentially reap the benefits of both levels of borrowing demand.
Global income generated from securities lending reached $ 7.1 billion in 2018 and $ 6.4 billion in 2019. It is no surprise that in what has been a highly volatile 2020, the income of Global securities lending since the start of the year are down about 20% through October.1 It should be noted, however, that global ETF unit lending revenue was $ 132 million through October 2020, a 26% year-on-year increase as market participants increasingly borrowed ETFs to gain broad market exposure.2
Additional yield potential
Each ETF’s lending landscape varies depending on the characteristics of the underlying holdings and market conditions. For example, a basket of small-cap stocks – such as those represented in the Russell 2000 Index – are generally more expensive and operationally complex to manage given their low liquidity compared to larger-cap stocks. The relative scarcity can result in attractive lending charges both on the individual securities and on the ETFs that hold the underlying securities. This can potentially contribute to favorable conditions for long holders looking to generate additional returns.
Also, in bearish market conditions, borrower demand for small cap stocks may increase. Investors with a long position in the iShares Russell 2000 ETF (IWM) can attempt to profit by lending the ETF itself to help offset the expense ratio and generate additional income potential.
Investing in a fund that owns and lends an ETF has historically enabled investors to achieve the desired exposure with the potential to continuously improve returns. ETFs such as the iShares Russell 2000 ETF (IWM) have always had a persistent demand in the loan market.
Use case: Long ETF holders looking for yield improvement opportunities
A pension fund manager held ETFs for long-term beta exposure. The manager spoke periodically with the iShares Markets Coverage team to identify which securities in its ETFs offered the potential for attractive loan returns. By lending these ETFs, the manager was able to:
- Maintain exposure to the ETF for the duration of the loan.
- Potentially offset the costs of managing the fund while seeking to generate additional income without deviating from the targeted exposure or asset allocation. (Note: Loan income may be split with the manager’s loan officer)
- Continue to receive any security distributions that occurred during the loan.
- Recall the securities loaned to the borrower at any time.
1 IHS Markit, January 2017 – October 2020
2 IHS Markit
There can be no assurance that there will be a demand by borrowers for shares of the iShares ETFs, or that the securities lending will generate any level of income. ETF equity lending income is not a component of fund performance and equity lending is not a service provided by iShares ETFs or BlackRock Fund Advisors, the investment manager of the funds and a subsidiary of BlackRock Investments LLC.
Carefully consider the investment objectives, risk factors and fees and expenses of the Funds before investing. This and other information can be found in the prospectuses of the Funds or, if available, in the simplified prospectuses which can be obtained by visiting www.iShares.com or www.blackrock.com. Read the prospectus carefully before investing. Investing involves risks, including the possible loss of capital.
This information should not be construed as research, investment advice or recommendation regarding any particular product, strategy or security. This material is strictly for illustrative, educational or informational purposes and is subject to change.
Small-cap companies may be less stable and more sensitive to adverse developments, and their securities may be more volatile and less liquid than larger-cap companies. Shares in iShares ETFs can be bought and sold throughout the trading day through any brokerage account. Shares are not individually redeemable from the ETF, however, shares can be redeemed directly from an ETF by authorized participants, in very large creation / redemption units. There can be no assurance that an active trading market for the shares of an ETF will develop or be sustained. Buying and selling ETF shares will incur brokerage commissions.
The iShares Funds are distributed by BlackRock Investments, LLC (together with its affiliates, “BlackRock”).
The iShares Funds are not sponsored, approved, issued, sold or promoted by Russell, and this company makes no representation regarding the advisability of investing in the Funds. BlackRock is not affiliated with Russell.
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