This semi-annual update discusses the current market dynamics that are impacting returns and risk, State Street Global Advisors’ core views as well as some client perspectives on securities lending.
The rally in securities lending returns experienced last year does not yet appear to be collapsing. After many years of a long-term secular decline in returns for securities lending (see Figure 1), the bounce over the past year seems to be more than just transitory. After the seasonally strong second quarter, returns only experienced a slight pullback, but remained consistently positive on a year-over-year basis. Moreover, the reversal of trend appears to be largely driven by intrinsic (or demand) returns. Reinvestment returns have declined since a peak after the surprise Federal Reserve (Fed) ease on the back of the Covid-19 outbreak, which led to a slight uptick in returns in 2020 but was brief in tenure. Approaching a year now, the securities lending return improvement has been more resilient, aided by a recovery in reinvestment spreads in the last few months (note: this is not yet observable in Figure 2 which shows trailing twelve-month averages).
Figure 1: Securities Lending Seven-Year Quarterly Returns
Digging further into the data, while there has been a broad uptick in securities lending returns across asset classes, the improvement is focused on US equities and corporate bonds. ETF and government bonds, while experiencing a gain in returns, are not up as dramatically. This suggests investors selling short are doing so on individual equities and credits, rather than macroeconomic views on markets or industries. This aligns with the demand in the lending market for specific equity securities that have focused on crypto, electric vehicle, and meme stocks. Additionally, there is still an abundance of supply of S&P 500 equities in the market, meaning most of the scarcity is focused on mid- and small-cap equities which have been driving higher returns.
Figure 2: Breakdown of Securities Lending Returns
In 2020, 33% of returns were derived from the reinvestment side of the equation; that trend has now reduced to about 16% over the trailing twelve months (see Figure 2). We can’t say how long this will last, but we believe, it does represent a strong and healthy incremental return to portfolios from securities lending. This is particularly can be attractive for securities lenders because returns are driven by the demand for securities in the market as opposed to incremental risk assumption on the reinvestment side of the equation.
State Street Global Advisors focuses on intrinsic value in securities lending and seeks to mitigate reinvestment risk to the extent possible. Firstly, State Street Global Advisors accepts non-cash collateral which eliminates reinvestment risk (including duration risk) entirely for loans collateralized by non-cash. This has been particularly useful in the current environment. Secondly, where securities are lent against cash, State Street Global Advisors’ Cash Team has managed the cash collateral reinvestment portfolios to shorter durations in this rising rate environment. This limits exposure to aggressive surprises in Fed policy and enables the reinvestment rates to rapidly readjust after Fed rate increases. State Street Global Advisors’ conservative approach to reinvestment exposure has served our programs well in the current rate environment.
State Street Global Advisors has continued to see increased demand for our securities lending programs from clients confident in our risk-managed approach. While on the surface it can be hard to distinguish differences in securities lending programs, we invest the time with clients – explaining and providing the transparency needed to understand these differences. While we experienced increasing returns from securities lending in 2022, our clients understand this is largely driven by increasing intrinsic value returns and not by the assumption of incremental reinvestment risk in the programs. We have heard appreciation for the quarterly factsheets on our securities lending programs that profile the risk and returns of the securities lending funds offered by State Street Global Advisors. The factsheets not only provide a snapshot individually, but also, taken together over time, provide the clarity of trends in risk and returns of the lending program, and enable our clients to confirm that we continue to adhere to our risk and return objectives.
For four decades, State Street Global Advisors has served the world’s governments, institutions, and financial advisors. With a rigorous, risk-aware approach built on research, analysis, and market-tested experience, we build from a breadth of index and active strategies to create cost-effective solutions. As stewards, we help portfolio companies see that what is fair for people and sustainable for the planet can deliver long-term performance. And, as pioneers in index, ETF, and ESG investing, we are always inventing new ways to invest. As a result, we are among the largest asset managers in the world with US$3.48 trillion* under our care.
*Pensions & Investments, as of December 31, 2022.This figure is presented as of December 31, 2022 and includes approximately $66.43 billion of assets with respect to SPDR products for which State Street Global Advisors Funds Distributors, LLC ( State Street Global Advisors FD) acts solely as the marketing agent. State Street Global Advisors FD and State Street Global Advisors are affiliated.
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