In securities lending, a number of macro themes are offering opportunities to generate returns. In the first half of 2018, we observed steady growth across all regions. Global on-loan balances increased by 10% over the same period in 2017 reflecting a more diversified set of opportunities.1  This, paired with the reintroduction of volatility in the US market, and economic uncertainty associated with Brexit in Europe, led to stable, long-term loans. Over the second half of the year, geopolitical headlines impacted the markets. Concerns around trade and tariffs, and a sharp market selloff, particularly in technology stocks, caught many hedge funds off guard, wiping out the year’s gains and causing a risk-off stance for the remainder of the year. This led to a reduction in volumes and fees as fund managers de-risked or cut losses. Demand can be difficult to predict because a shift in the broader market can mean big swings to lending activity. However, here are the top five trends we expect to see in securities lending in 2019.

1.    The Impact of Passive Investing

Globally, low yield environments and the need to plug pension deficits are both driv­ing increased interest in the returns secu­rities lending can provide, but in the asset management sector specifically, it is the ex­ponential growth of passive investing which is having the most impact and bringing se­curities lending closer to the core of asset managers’ business.

For a low-cost passive fund like an ETF, addi­tional basis points offered by securities lend­ing are key to more closely tracking its index by offsetting the impact of the annual man­agement fee. Of the managers representing 95% of ETF AUM, only two are not lendingdemonstrating how ubiquitous securities lending has become for these products.  

The passive investing phenomenon has prompted investment managers to evaluate the role securities lending can play in help­ing to mitigate the impact of their compara­tively higher fees on performance. Today, 16 of the top 20 global managers by net new sales participate in securities lending3 and we expect that number to increase in 2019 given the competitive cost pressures at play.

2.    Steady and Cautious

We expect lending demand to be steady, but recent and expected market volatility and related hedge fund de-risking may con­tinue to introduce headwinds. Additionally, several macro headwinds could impact borrowing demand such as rising trade tensions between the US and China, an economic slowdown in China, and an in­crease in political strains in Europe (Brexit and Italy).

3.    Strong Demand in the US

In 2019, a maturing economic cycle will in­crease its influence on the US economy as elevated volatility, dispersion of corpo­rate earnings, and credit concerns will likely come into focus. With the predicted pace of the US Federal Reserve (Fed) rate hikes slowing, moderate growth expectations, and continued elevated political risk, it is our expectations that securities lending demand will be resilient in the first half of 2019 as investors position accordingly.

In addition, the reemergence of market volatility may have an impact on financial conditions which could create greater price dispersion and coloration amongst securi­ties. This could lead to more favorable stock picking environment both on the long and short side of the market. We expect de­mand to be resilient in the first half of 2019.

4.    Challenges Spur Lending in Asia

We expect Asia lending demand to be driven by several sectors that faced challenges in 2018. In China, the education sector is fac­ing new challenges due to regulation that encompasses private operators. Chinese automobile manufacturers are also facing headwinds as the industry is experiencing a broad slowdown in demand for vehicles. In South Korea, we expect more demand for lending following concerns the pharma­ceuticals sector is overvalued.

5.    Brexit Dominates in Europe

For Europe, the Brexit story continues. We have seen many of the themes affect­ing lending demand spill over into the new year with no respite for the retail markets which suffered throughout 2018. Brexit will continue to dominate headlines as the UK Prime Minister Theresa May seeks to close divisions within parliament and hopes to en­sure that a deal is agreed prior to the 29 March deadline. The outcome of the final deal could have large ramifications for many industries, including financial services, but also industries such as aerospace, auto­mobile, and manufacturing in the UK and throughout Europe.

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IS-04709-2019-01-30

1ISLA
2By BBH analysis
3By BBH analysis