Securities Lending: A Possible Alpha-Generating Source of Fund Revenue

In the newest installment of #TALKtoUltimus, a podcast series from Ultimus Fund Solutions, James McGuire, Senior Manager for Adviser Services at Ultimus, interviewed Brooke Gillman, the Managing Director of Client Relationship Management for eSecLending. You can listen to the full podcast *HERE. 

The information below is an introductory overview of Mr. McGuire’s discussion with Brooke, exploring the potentially alpha-generating tools that are driving fund advisers and asset managers to make competitive decisions in today’s changing industry, and why the Securities Lending space is growing due to fee compression and other factors.

What is Securities Lending?
Securities Lending is a collateralized transaction that takes place between two institutions. Investors make loans of their securities to generate incremental revenues from their portfolios. Typically, the lender temporarily transfers the title of the security and its associated rights to a borrower, in exchange for a fee. That borrower is required to return the security either on demand (as an open loan) or at an agreed date in the future (term loan).

Lenders mostly are mutual funds, global pension funds, insurance companies, investment funds, Exchange-Traded Funds (ETFs), and sovereign wealth funds. In most cases, institutional investors lend securities for one main reason – to improve performance.

Current Market Trends
According to Brooke, Securities Lending today is considered a potentially alpha-generating investment process that has grown significantly over the last several years to become a core piece of the investment strategy. From what was once considered more of a back-office function in the industry, funds today are engaging in Securities Lending as an attractive way to potentially add additional revenue to their funds and ultimately, make money for shareholders.

Part of the reason why the product is growing in both fund participation and activity is in large part due to the increased pressures and competitiveness of the industry. With fee compression, as well as new growth of passive funds, ETFs, and other mutual funds, everyone is now heavily competing for investors.

From the viewpoint of eSecLending, if investors and asset managers today are not engaged in Securities Lending, they are potentially leaving additional returns for shareholders on the table that can be generated via the possible incremental alpha, and therefore are at a competitive disadvantage versus their peers.

How Funds Benefit
As a type of alpha-add to the investment product, Brooke explains that there are two primary components to Securities Lending. The first is the intrinsic value that can be generated from the activity of putting securities in the funds out on loan to a counterpart in the market. The second is the collateral that is received back versus the loan when it’s cash (per most mutual funds in the U.S.) that can then be reinvested. Benefits to the lending transaction are the fees made from the loan and the additional incremental yield generated through the cash reinvestment strategy.

The Risks
Since there are always risks in the financial market, lenders should be clear about the objectives of their securities lending program per the Securities Lending Policy shared with the agent (e.g., eSecLending). A lender’s objectives and parameters are important factors driving both their risk and return profile. The objectives for lending may include liquidity, leverage, or both.

To hear more from Brooke about how investors can potentially increase alpha in the Securities Lending space, listen to the full podcast *HERE. 

*The podcast contains the views and opinions of eSecLending. eSecLending and Ultimus Fund Solutions, LLC are not affiliated. 

Headquartered in Boston, MA, eSecLending is an independent, third-party securities lending agent. The company delivers client-tailored, securities lending solutions that seek to achieve higher risk-adjusted returns, greater transparency, and stronger alignment of interests as compared to traditional, pool-based lending programs. The goal is to deliver investment management practices that focus on best execution, price transparency, and benchmarking.

Brooke Gillman is Managing Director, Client Relationship Management for eSecLending. She manages the Client Relationship global team and is responsible for leading the firm’s service model for all client programs. Brooke also oversees the firm’s marketing and communications activities. She joined the company in 2000 as one of the founding members. During her tenure, Brooke has held various senior positions with the firm in Business Development, Client and Product Management, and as Director and Vice President for Marketing and Corporate Communications, respectively. She earned a bachelor’s degree in Business Administration from the University of Washington.      

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