Unlocking the Securities Lending Potential of SPY
- Relying on the expense ratio to assess an ETF’s total cost is limiting — it’s crucial to consider other factors like securities lending potential.
- Securities lending, an essential component of capital markets activity, facilitates settlement, injects liquidity, and fosters confidence for risk taking.
- SPY accounted for an estimated average of 93% of S&P 500 ETF notional short interest and 28% of total ETF notional short interest in 2022.
Relying solely on the expense ratio of an exchange traded fund (ETF) to assess its total cost can be limiting. That’s why it is crucial for institutional investors to consider additional factors — like securities lending potential — when selecting the right ETF to trade.
Compared to other investment vehicles tracking the S&P 500 Index, the SPDR® S&P 500® ETF Trust (Ticker: SPY) delivers a specific cost offset advantage through its unique lending market.
Securities Lending with ETFs
Securities lending, or the exercise of loaning securities to other investors, is a key aspect of capital markets activity that facilitates settlement, injects liquidity, and fosters confidence for risk taking. These benefits are accessible to all types of investors, spanning from long-term stable asset base investors to more active participants, like hedge funds or market makers.
ETF securities lending has grown alongside broader adoption of the structure. Many investors may be familiar with “inside” lending, or the practice in which ETF issuers lend out the constituents of the ETF. “Outside” lending, however, refers to when ETF beneficial owners make their ETF shares available for borrowing.
In some cases, “outside” lending can serve as a more relevant driver of returns, with the potential to earn lending returns that offset the fees of the fund.
The Unique Nature of SPY Securities Lending
At the forefront of most ETF capital markets activity stands SPY, the world’s largest and most actively traded ETF.1 For SPY, securities lending is an important contributor to the overall efficiency of secondary market trading.
Through the first three quarters of 2022, SPY represented an estimated average of 93% of S&P 500 ETF notional short interest and 28% of total ETF notional short interest from among 2,900 US-listed funds.2
Most importantly, SPY’s year-to-date $40B in average daily secondary value traded accounts for more than 20% of all ETF trading.3 As different users meet on the exchange, centralized pools of liquidity form, benefitting all users of SPY. And as different investors access SPY’s liquidity, demand to borrow SPY shares ebbs and flows with market dynamics across use cases.
Why Investors Borrow SPY
Borrowers of SPY are typically hedge fund managers, investment managers, options traders, or market makers that are seeking to: short, hedge, cover pending settlements, and create arbitrage opportunities. Two notable persistent drivers of supply and demand are the following:
Listed Options
- SPY represented 99.2% of S&P 500 ETF options contract open interest and 17.9% of total ETF options contract open interest at the end of Q3 — that’s greater than 46% of all ETF options open interest on an estimated notional basis.4
- On a transactional basis, SPY’s average of 6.9 million contracts traded per day through the first three quarters represented greater than 45% of all ETF options trading.5
Fungibility with Futures
- SPY is a significant bridge between futures and cash markets.
- Given the availability of liquid futures contracts tracking the S&P 500 Index, an investor can hold SPY and sell an S&P 500 futures contract as a market neutral arbitrage strategy.
- From a securities lending perspective, this natural hedge provides an incentive for banks to carry SPY shares — ultimately making them easily accessible to borrow within the institutional trading community.
Potential Yield from Lending SPY?
When evaluating the potential yield generated from securities lending, we can look at the volume-weighted average fee (VWAF) and the utilization rate percentage:
- The VWAF represents the average fee charged by a lender to a counterpart expressed in annualized terms.
- The utilization rate is the shares on-loan as a percentage of shares made available for loan.
To demonstrate the potential return on shares made available, we can multiply the VWAF by the utilization rate to determine the historical return on lendable assets, as shown below.
Ticker |
Fund Name |
Trailing 1-Year Average |
||
VWAF bps |
Utilization Rate % |
Gross Return on Lendable Assets (bps) |
||
SPY |
SPDR S&P 500 ETF |
15 |
50% |
7.5 |
IVV |
iShares Core S&P 500 ETF |
9 |
4% |
0.4 |
VOO |
Vanguard S&P 500 ETF |
11 |
11% |
1.2 |
Source: Markit IHS as of September 30, 2022; Estimates are for illustrative purposes only and do not include additional return factors such as agency lending fees, reinvestment rates, or other considerations. Past performance is not a reliable indicator of future performance.
Relative to its peers,6 SPY’s historical return on lendable assets reflects how the fund’s broader user base supports consistent demand. And, it underscores how vital it is for institutional investors to look beyond a fund’s expense ratio to consider factors like securities lending potential and transaction costs when selecting the right S&P 500 ETF.