To lend or not to lend?


We examine the impact of securities lending on asset prices and fund performance.

February 2023

Travis Whitmore

Travis Whitmore
Senior Quantitative Researcher
State Street Associates,
State Street Global Markets

Since institutional investors started lending in the early 1970s, there has been an ongoing debate: To lend or not to lend? Should investors lend securities for additional revenue, or avoid lending due to concerns of short selling? The debate often focuses on securities lending’s potentially negative impact on stock prices through the facilitation of short selling. Specifically, beneficial owners question the impact that the ultimate borrowers of securities, who may be short selling the stock, have on market functionality and the value of the stocks on loan. Whether or not securities lending is detrimental to markets and fund performance has been a longstanding discussion in many corners of the financial world. This has attracted the interest of financial researchers, who look to address this through empirical evidence.

In this article, we delve into and summarize a number of key papers, findings and quantitative approaches across academic literature to address the question: Is securities lending detrimental to asset prices and market functionality, thus leading to portfolio underperformance? We have analyzed over 20 wide-ranging studies primarily sourced from highly regarded peer-reviewed journals, such as the Journal of Finance.

At first glance, the relationship between securities lending and asset prices may seem unclear. For example, a large body of research shows that high levels of utilization (shorting demand relative to lending supply) predicts negative returns. This suggests that securities lending leads to price declines. However, a closer look at empirical evidence suggests that while shorting demand is an important bearish signal and may predict negative future stock returns, lending supply is not the cause of stock price declines. In fact, data shows that supply-constrained stocks tend to underperform those with higher levels of supply on a forward-looking basis.

Regarding fund performance, there are important nuances between passively and actively managed funds, but the weight of empirical evidence finds that securities lending improves fund performance by contributing to net investment income and reducing tracking error without detracting from share value. As it relates to short selling’s impact on capital markets, academic findings indicate that short selling improves market efficiency and provides liquidity, particularly when it is needed most.


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