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Securities lending and the Russell 2000: May I borrow your small caps?

By: Tom Goodwin, Senior Research Director

In a previous post, I examined the surprising historical tendency of small caps to outperform large caps in periods of slow economic growth. Given the current market climate, the small cap market segment may be worth a look. As income opportunities remain scarce, managing the costs of any investment is particularly important to optimize returns. Market participants have widely adopted securities lending strategies as a way to achieve this aim.[1]

A highly liquid ecosystem of investment products has grown up around the small cap Russell 2000 Index since its inception in 1984. These products consist of exchange traded funds (ETFs), futures and options. The growth of ETFs which are based on the Russell 2000 has provided market participants with the ability to trade a physical security (ETF) for the purposes of hedging and shorting small cap exposures.

To hedge or short small cap exposures, the ETF must be borrowed. This has created an opportunity for those market participants holding small cap ETFs to lend out their shares for additional income. Several large institutions have successfully operated this type of “long and lend” opportunity. For example, the California Public Employees’ Retirement System (CalPERS) earned approximately $2 million in securities lending income for the 2014-2015 fiscal year.[2]   

We can see how the securities lending process works in the illustration below. An investor holding an ETF can engage in a “long and lend” strategy by lending the security to a borrower through a lending agent. In doing so, the lender will receive liquid collateral plus a premium for the duration of the loan. 

The lender benefits from the premium paid over the value of the ETF, plus any income generated when the collateral is reinvested. The primary risks associated with this strategy are counterparty and reinvestment risk. However, these risks can be significantly mitigated through strong risk management, conservative investment guidelines, ongoing credit reviews and the daily mark-to-market of collateral.[3]

Establishing a separate account that holds and lends an ETF based on the Russell 2000 Index, therefore, can provide market participants with an index-based exposure to small caps with the added potential for income enhancement. Through the lending agent, the market participant stands ready to respond to anyone asking, “May I borrow your small caps?”

For further insights on this subject, please see: “The Russell 2000 Index, small cap performance in a slow-growth economic environment.”


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[1] Correspondence with Market Securities Finance.

[2] Comprehensive Annual Report, Fiscal Year Ended June 30, 2015, CalPERS, Nov. 2015.

[3] “Securities Lending Best Practices”, Securities Finance Trust Company, 2012.


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