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Securities Lending Fees as a Short-Term Driver of Stock Returns

Investing Insights

Securities Lending Fees as a Short-Term Driver of Stock Returns

By Kaitlin Simpson Hendrix Researcher   |   Gavin Crabb Portfolio Manager and Vice President

Securities lending involves the owner of a security (the lender) temporarily transferring ownership of the security to an investor (the borrower) in return for compensation. Traditionally, the value added from securities lending comes from the revenue generated from the fees lenders receive from borrowers. Dimensional has engaged in securities lending for many years in its efforts to enhance returns for fund shareholders. Research by Dimensional shows that market participants may be able to further enhance their investment outcomes by using information from prices in securities lending markets to identify short-term differences in expected returns across stocks.

We examine the informational content embedded in securities lending markets by testing the relation between the price to borrow stocks, or borrowing fees, and subsequent stock performance. Using data from 14 global securities lending markets1 for 2011-2018, we find that stocks with high borrowing fees tend to reliably underperform stocks not on loan over the next several days, and that this relation is more pronounced within small cap stocks.

High fee stocks that remain high fee one year later tend to drive this underperformance. Our research shows, however, that the persistence of high fees is not systematically predictable. While the relative magnitude of borrowing fees and borrowing utilization contains some information about the likelihood of high fees to persist, their predictive power is not sufficient to reliably identify which high fee stocks will remain in that group over time.

To incorporate these research insights into a robust investment process, we need to carefully balance the tradeoffs between expected return, revenue from lending activities, diversification, turnover, and trading costs. Our findings suggest that turnover and costs can be potentially high if buy and sell decisions are triggered by stocks crossing frequently the high fee threshold. Instead, we believe that an efficient approach to incorporate the information in borrowing fees into a real-world investment process is to consistently exclude from additional purchase small cap stocks with high borrowing fees.

FOOTNOTES

  1. The following countries are included in the analysis: Australia, Canada, China, France, Germany, Hong Kong, Japan, Korea, Malaysia, Singapore, Sweden, Thailand, Turkey, and United States.

DISCLOSURES

Securities lending involves risks. Revenue is not guaranteed and may fluctuate. Lending activities are conducted by the Custodians for the funds. Diversification does not eliminate the risk of market loss. Past performance, including hypothetical performance, is no guarantee of future results.

Securities lending is an over-the-counter market that involves the borrowing and lending of securities predominantly for the purpose of covering short-sale positions. Participants include pension funds, mutual funds, and foundations, which lend their security holdings, as well as option traders, hedge funds, and other asset managers, which borrow security holdings. These parties rely on their respective intermediaries (custodians for the lenders and prime brokers for the borrowers) to broker their transactions and manage counterparty risk. Diversification does not eliminate the risk of market loss.

The information in this document is provided in good faith without any warranty and is intended for the recipient’s background information only. It does not constitute investment advice, recommendation, or an offer of any services or products for sale and is not intended to provide a sufficient basis on which to make an investment decision. It is the responsibility of any persons wishing to make a purchase to inform themselves of and observe all applicable laws and regulations. Unauthorized copying, reproducing, duplicating, or transmitting of this document are strictly prohibited. Dimensional accepts no responsibility for loss arising from the use of the information contained herein.

“Dimensional” refers to the Dimensional separate but affiliated entities generally, rather than to one particular entity. These entities are Dimensional Fund Advisors LP, Dimensional Fund Advisors Ltd., Dimensional Ireland Limited, DFA Australia Limited, Dimensional Fund Advisors Canada ULC, Dimensional Fund Advisors Pte. Ltd, Dimensional Japan Ltd., and Dimensional Hong Kong Limited. Dimensional Hong Kong Limited is licensed by the Securities and Futures Commission to conduct Type 1 (dealing in securities) regulated activities only and does not provide asset management services.

UNITED STATES: Dimensional Fund Advisors LP is an investment advisor registered with the Securities and Exchange Commission.