Securities finance is an integral aspect of an investment portfolio and consists of portfolio margin or leverage and stock borrow\loan (settle shorts and lend longs). Financing costs can make a significant impact to a portfolio’s returns adding 50 to 200 basis points (bps) of expense, and sometimes more, to the bottom line depending on the securities traded. While margin and leverage costs are usually standardized within a prime brokerage or brokerage agreement, stock borrow\loan costs and revenues will vary daily depending on the underlying securities in a portfolio.
Stock borrow sometimes is an ignored aspect to the profitability of a trade because the financing expense effect is usually assumed to be minimal, but not every trade has the 30 bps cost of a general collateral (GC) borrow and has the capability to take a big bite out of expected alpha. Total 2022 and 2023 equity stock borrow financing costs for US shorted stocks came in at $6.9 billion per year, which was a significant offset to alpha generation.
While the notional amount of short interest was skewed to GC and easier to borrow stocks, stock borrow costs were bar belled between the easiest to borrow stocks and hardest to borrow stocks. A third of stock borrow financing costs were incurred by shorting GC stocks even though these trades made up over four\fifths of total dollars shorted while over two\fifths of stock borrow financing costs were incurred by shorting stocks with over 10% stock borrow fee while making up less than 2% of dollars shorted. Short sellers had significantly less dollar exposure in the harder to borrow\more expensive stocks but over two\fifths of their stock borrow expense was generated in those stocks.