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Corporate bond ETFs top most revenue generating funds
Equities deliver 75% of total ETF revenues
The increasing presence of exchange traded funds in the capital
markets has extended to many classes of investors, with retail
investors seeking low fee passive vehicles, while operational ease
of use has drawn many institutional investors. The total AUM for
global ETFs reached $5tn this year, an increase of $280bn compared
with end of 2017. The increasing use by institutional investors is
reflected by the growth in lendable assets in securities lending,
which also reached a new high this year, though like total AUM, has
declined with markets in Q4. Compared with 2017 average, global ETF
lendable assets have increased by $58bn in 2018.
The revenues associated with lending those portfolios have also
been trending higher, with the $342m in YTD revenues poised to best
the 2017 total of $345m before the end of November. The $52bn in
average balances QTD is the highest on record for any quarter,
despite the sell-off in global assets. The good news for ETF
holders is that utilization of lendable supply has also trended up
this year, from 9.1% in Q1 to 11.3% in Q4.
The key driver of borrow demand: exchange traded products are
popular with short sellers, as they allow for the efficient
expression of a view on a wide range of asset classes. That allows
hedge funds to gain short exposure to a given sector or asset class
both as a directional view or as a hedge to a specific long. At the
top of the list of most revenue generated funds YTD: the USD
high-yield index tracking funds HYG and JNK, though, equity funds
drive the bulk of total revenue (75% QTD, up from 70% in Q3). The
$52bn in borrowed ETFs equates to roughly a third of short
positions reported to exchanges. The other two thirds are largely
created from borrowed fund constituents which are exchanged for
units of the ETFs. The ability to "create to lend" often keeps a
lid on the lending fees for holders of the ETFs; however, the
products which are more challenging to create can still command
non-GC rates (for example, JNK and HYG currently have fees greater
than 200bps.)
Not all ETFs can be created out of borrowed securities, in
particular those with exposure to illiquid asset classes. One such
example is the Invesco Senior Loan ETF, BKLN, which consists of a
basket of leveraged loans. The fund has seen increased demand from
short sellers in Q4, with over $800m in current loan balances. Only
a small handful of the underlying loans have any availability in
securities lending, so borrowing shares from long holders of the
ETF is essentially the only means of sourcing the borrow. Lenders
have attempted to pass through increased rates, though the
increased fees in late October and early November saw an immediate
response of returned shares, driving fees lower. Once the borrow
fee declined the balances picked up and fees have started to move
up again. It's worth noting that BKLN has a 67bps expense ratio,
which means that if short sellers can borrow for less than that
rate there is an arbitrage assuming no movement in the underlying
asset class. Additionally, the YTD increase in OBFR means that
short selling any easy-to-borrow asset will result in a positive
rebate to cash proceeds.
Generally speaking, hedge funds would prefer to be short ETFs
with higher expense ratios, as that is a direct drain on the fund's
performance; however, most funds will achieve securities lending
revenues which partially offset the fund expenses, making this
analysis less precise for funds which lend. Another factor in
selecting exchange traded products for short positions is the
liquidity of the ETF shares. Looking at the S&P 500 tracking
funds as an example, SPY has a higher expense ratio than VOO, and
is also more liquid in the cash market, making it the preferred
choice for short sellers. That preference is clearly expressed in
the comparison of short balances, where SPY currently has over
$50bn, more than 100x the short balances in VOO.
The continued proliferation of exchange traded products shows no
sign of stopping, both in terms of AUM and product count. The Q4
sell-off has only reduced AUM to the level observed in Q2 and is
still 5% above Q4 2017. As far as product count, there are now over
eight thousand exchange traded products, with more than a thousand
new entrants over the last 12 months. Holders of these products
continue to see increasing total revenues and the increasing
utilization means that returns to portfolios in lending programs
are also increasing as a percentage of assets.
Posted 27 November 2018 by Sam Pierson, Director of Securities Finance, IHS Markit
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