Dwayne Buzzell Blog | Securities Finance Adding to Increased Interest in Passive Funds | Talkmarkets

Dwayne Buzzell

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An economist, Forex trader and Forex writer, I have a keen eye for spotting international trading trends, particularly since shadowing my mother’s work over the past 20 years with one of the largest fashion groups.

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Securities Finance Adding to Increased Interest in Passive Funds

Date: Wednesday, November 15, 2017 8:49 AM EDT

In the June issue of Securities Lending Times, Simon Colvin of IHS Markit reports on the growing passive funds market and its utilization of securities lending and borrowing. According to Colvin, two-thirds of the global securities lending inventory is now associated with passive funds. These funds have been significantly growing in assets under management and also significantly increasing their utilization of the securities finance market. This trend in passive funds securing lending has been specifically evident as passive fund securities lending inventory has growing from only half in 2008 to its current level of approximately two-thirds.

Passive Funds and Securities Lending and Borrowing

Passive funds have been significantly growing, reporting four times the growth in comparison to active funds since 2007. Since 2007, these funds have reportedly grown by 230% to a total asset value of $6 trillion. Assets in active funds still significantly outsize passive funds at $24 trillion however since 2007 these funds have only grown assets by 54%. A number of factors have influenced greater interest in passive funds including low interest rates, high active management fees, and lower tolerance for risk and performance volatility.

Market speculators believe the trend in passive investing will continue and one factor adding to the attractiveness of the funds is their successful use of securities lending and borrowing. In the fund management industry, securities lending and borrowing within passive funds has outperformed its comparable active funds by 14% reporting a three-year average annual return of 0.051% versus 0.045% by active funds. According to Colvin, one main difference for the outperformance is that passive funds have broader provisions for collateral in securities finance transactions.

Collateral Acceptance by Passive Funds

In securities lending and borrowing transactions, lenders can accept cash collateral or a wide range of non-cash securities. Individual markets have different requirements for acceptable securities beyond cash. Government bonds are typically the most favored collateral asset. Passive funds have been able to historically outperform other categories by agreeing to broader collateral standards and accepting lower credit quality assets. In the current market, approximately 80% of passive funds are reporting fund management provisions that allow for lower credit quality assets with G10 bonds and equities eligible as securities finance collateral. In comparison, active funds have reported much higher securities finance collateral requirements, with 36% of funds accepting only G7 bonds.

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