Securities Lending & ETFs: Better Together?

  • Investor Services
With increased competition and growth of ETF products, BBH's Tom Poppey, Antonette Kleiser, and Tim Huver discuss why managers are increasingly turning to securities lending as a core piece of their investment programs.

With performance and low fees top of mind for ETF managers, the income generated from lending the underlying securities held within the ETF make a strong pairing to increase competitiveness and offset fund costs. It’s not a surprise that the top 10 ETF issuers, together representing 80% of global ETF assets, globally engage in securities lending programs on behalf of their ETFs.1

In addition, there are emerging opportunities for asset managers to lend the ETF vehicle as well. In fact, the lending of ETFs currently accounts for only a fraction of the total ETF assets held by investors - 2.6% of the total value. However, that figure has grown from 1.8% in 2017,2 indicating that both the available supply of assets enrolled in lending programs as well as the borrowing demand is increasing under current market dynamics. This is likely to only grow as 1,277 new ETFs have been launched year-to-date by 297 providers.3

With a confluence of trends in the ETF asset class, and wider industry shifts, including T+1, the time to look closely at ETF securities lending, with a specialist provider, is now.

Growth of ETFs

Assets are flowing into a $9.23 trillion ETF market at a blistering pace and by 2033 the market is expected to be worth more than $30 trillion as BBH forecasted in the 2023 Global ETF Investor Survey. With that in mind, managers are eager to realize the benefits of this growth and seize upon three trends where layering in securities lending has the most impact:

  1. Mutual fund to ETF conversions: This is particularly useful for active managers as lending may help them outperform the benchmark, and potentially generate additional revenue for institutions as well as on the ETF - well beyond the mutual fund.
  2. Expansion of ETFs in Europe: Europe’s share of global ETF flows is already at 39%,4 and growing. The launch of ETF share classes should provide a further boost.
  3. Increase of new ETF products: With AUM in thematic ETFs surging, managers could have an opportunity to earn significant revenue through lending their underlying securities.

Returns on lending both the underlying ETF assets and the ETF themselves, have increased over time, with high utilization rates in line with the ETF universe. However, the goals for each are different.

For the underlying securities to an ETF, it’s about improving performance to offset management or operating fees. Lending revenue is credited to the ETF, helping passive managers better track the index, as well as potentially outperform it for ETF investors. For active managers, lending helps them improve their performance and achieve their goal of outperforming the benchmark. As an example, managers saw solid return contributions from emerging markets indices such as MSCI (see Figure 1).5

Figure 1: Securities lending return contribution for select indices

 

  Indicative Securities Lending Return Contribution (in bps) Trailing 12-month
Select Equity Indices  
MSCI Emerging Markets
7.7
MSCI Asia ex-Japan
5.0
MSCI Europe
3.8
MSCI Japan
2.9
MSCI World
1.3
MSCI USA
0.6

Past performance does not guarantee future results.

Source: S&P Global Market Intelligence - from November 2022 to November 2023

On loan balances of individual ETFs also paint a strong picture, having increased at an impressive CAGR of 15% since 2020 globally, led by the U.S.. Global ETF AUM shows a similar trajectory with assets having increased 11.3% year-to-date in 2023. Product expansion has supported ETF borrowing, providing a mechanism for professional investors to gain short exposure to both broad and niche segments of the market. Here, it's a demand story with average lending fees earned on ETF shares climbing to 67 bps globally in 2023.6 The demand for ETFs is creating increased liquidity and lending opportunities in the market.

Why does ETF lending matter now?

For many ETF managers, securities lending was traditionally put off until after the fund was well established in the market. However, more managers are now embedding securities lending prior to launch and as a proactive part of their investment strategy. This allows for potential additional returns, better performance, and enhancement to sales and distribution efforts.

Emerging technologies can also help assess the securities lending return opportunity. These have proved particularly useful for active ETF managers looking to reduce their costs and may be another tool to minimize their expense ratios.

Given the growth of ETF securities lending and recent trends it’s no longer about whether to lend, but how to lend. Here, a focus on ensuring you’re getting the most out of your program will be key.

1ETFGI as at Sept 30th, 2023
2ETFstream.com July 25th, 2023
3ETFGI as at Nov 30th, 2023
4Bloomberg Intelligence March 2023
5S&P Global Market Intelligence
6S&P Global Market Intelligence

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