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, writes Catherine Yoshimoto, director for product management at FTSE Russell, an LSEG business.
This trend is evident in the recent increase in securities lending activity. In 2022, large institutional investors earned a total of $12.5 billion in securities lending revenues – representing a 15% increase from the previous year. The California Public Employees’ Retirement System (CalPERS), for example, has implemented a “long and lend” strategy and earned nearly $1 million in securities lending income for the 2021-22 fiscal year.
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. In this strategy, 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.