Higher demand for stocks is providing a shot in the arm to securities lending programs at most pension funds.
Estimated securities lending revenue for most pension funds in the second quarter increased by an average of 20% from a year earlier, said Craig Starble, executive vice president and head of securities finance at State Street Corp., Boston.
The California Public Employees’ Retirement System, Sacramento, raked in $150 million from securities lending for the year ended March 31, an increase of $21 million, or 16%, from the year before. The $247.9 billion pension fund is anticipating more than $160 million in securities lending revenue for the fiscal year that ended June 30. The system has about $160 in securities available for lending.
“The increase in demand from both hedge funds and the 130/30 market have driven interest in our auctions,” said Daniel E. Kiefer, opportunistic portfolio manager at CalPERS. “With the advent of 130/30s coming on board, your second tier (prime brokerage firm) is very interested in getting access to loanable securities,” which drives up overall demand.
Morgan Stanley Prime Brokerage, Goldman Sachs & Co. and Bear Stearns Cos. Inc., all in New York, have the dominant share of prime brokerage business, Mr. Kiefer said. Smaller prime brokers are trying to gain access to more exclusive relationships with securities lenders to boost their book of business and compete with the major prime brokers for hedge fund clientele and traditional managers that are using shorting for the first time with 130/30 strategies.
“If there’s a new entrant in the system, that pushes the demand up,” Mr. Kiefer said.
Filling the void
“There’s a pure volume demand on securities to short. … Big pension funds are filling that void right now,” added Steven Lambdin, assistant director of equities for the $33 billion Retirement Systems of Alabama, Montgomery.
The Alabama fund made about $10.5 million in securities lending revenue for its fiscal year ended Sept. 30, and Mr. Lambdin says the fund will make at least 20% more this year. The plan has $20 billion is available to lend, with $3.2 billion out on loan.
The $82 billion Ohio Public Employees Retirement System, Columbus, is also seeing gains, to $38 million in 2006, up 31% from $29 million in 2005, said Jerry May, securities lending and cash manager.
Along with hedge funds and 130/30 strategies, growth in the market value of assets and increased merger-and-acquisition activity are seen by custodians and pension fund officials as reasons for increased demand.
When there is a lot of M&A activity, “there’s a lot of borrowing for arbitrage going on behind the scenes,” Mr. Lambdin said. “Some of those deal stocks are 2 or 2½ times their normal spread.”
The impact of new 130/30 strategies has not been fully felt yet, but is expected to boost securities lending revenues significantly in the future. “This is a small component but a growing component,” said State Street’s Mr. Starble.
Mr. Starble estimated pension funds will put $500 billion in 130/30 strategies over the next few years, which would mean a lot more demand for securities to borrow. “These are not dollars taken away from a hedge fund or other strategies. These are from traditional long only-managers.”
Executives at the newly merged Bank of New York Mellon Corp. agree. “We anticipate the demand will grow as the use of these strategies gets greater and greater,” said William P. Kelly, managing director of Bank of New York Mellon Asset Servicing, New York. “If there is more competition for borrowing these securities, it could lead to more demand and wider spreads.”
While asset-servicing executives say increased investments in 130/30 strategies will boost securities-lending revenue, they are also looking for ways to use securities-lending programs to cut the cost of using 130/30 strategies in a pension fund’s investment portfolio.
Fees for a 130/30 strategy are higher than long-only mandate fees in part because the manager must go to a prime broker to borrow securities to short. JPMorgan Securities Lending, New York, is helping reduce the cost by working with the pension fund and the 130/30 manager it hires, lending securities to the manager from the fund’s own long-only portfolios.
Cost-effective solution
“When we package all that up together we can provide a cost-effective solution to the pension fund to get into these 130/30 strategies,” said Paul Wilson, managing director and global head of client management for JPMorgan Securities Lending, London.
State Street is developing the same type of service for its clients, Mr. Starble said.
For pension funds with at least $10 billion in assets, Mr. Wilson estimates 30% to 50% of the stocks shorted by their 130/30 managers can be borrowed internally. That would cut manager transaction costs, and the savings could be passed on to the pension fund through lower fees.
The concept of loaning securities from a long portfolio to 130/30 managers to short is still new to pension funds, with only about 5% of JPMorgan’s pension fund clients using it, Mr. Wilson said.
