1. If you aren’t stock lending yet or issuing stock loans, you should seriously consider starting

Some people may be concerned about making their securities available for loan to short-sellers. I am not going to get into the philosophical debate about the merits of short-selling here, but if you think that you joining the market is going to enable short sellers further, think again. There are already over $20 trillion of securities available for loan from a broad array of investors segments around the world, so unless you have a huge small-cap portfolio that’s new to the market, it’s unlikely you will be changing the supply/demand dynamics.

What I can tell you for sure is that investors that are lending are capturing revenues you aren’t. To my way of thinking, in a falling market, every basis point counts.

2. If you are lending, take the broadest range of collateral you can

Make certain you accept as wide a range of collateral as possible across both cash and non-cash (within your risk and regulatory parameters). I’ve been telling investors to do this for a long time, so why am I stressing it again now? In a podcast last week by the good people at eSecLending they raised several timely points that reinforce this recommendation. I suggest you listen to the entire podcast but let me raise two points. When markets fall, hedge funds are amongst the investors who sell long equity positions, both cash and synthetic. That means that prime brokers have fewer equities to provide as collateral. For the stock positions that are still held by prime brokers and hedge funds, market price drops reduce their value in daily mark-to-market valuations.

This shortfall is usually made up of cash collateral. If you only take non-cash, you are excluded – zero returns while your portfolio is dropping in value. Cash collateral takers can also benefit from the maturity spread of a diversified reinvestment portfolio that can ride out a short-term performance hit; the likely consequence of moving to higher-quality, more liquid but lower-yielding assets for a period. Of course, cash collateral brings additional risk, so do your homework when shifting to or away from any type of collateral.

3. Review your securities lending governance

I think that having good securities lending governance is the key. Often people think of governance as it relates to portfolio restrictions and approach to voting, and of course, these are two solid components of a good governance policy. But that’s not enough. All the points I’ve raised here should be part of a governance document that sets out the principles, parameters and practices for an investor’s engagement in securities lending. Additionally, areas such as ESG need to be part of a comprehensive securities lending strategy for each participating investor.

Perhaps controversially, I believe that even investors that don’t lend should have a governance statement in place articulating why they don’t participate in lending. After all, if for example, my pension fund’s return is diminished because someone has taken the decision not to generate alpha from securities lending, I would want to know the reasons why.

By on July 8, 2020   /   Blog  
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