Unveiling Mutual Funds' Securities Lending Strategies: Value versus Volume

Abstract

Using mutual funds' securities lending patterns, we propose a data-driven method using association rules to differentiate shorting demand for general hedging and for exploiting firm-specific negative information. This method enables us to classify funds into two distinct lending strategies: value lending (low quantity and high fee) and volume lending (high quantity and low fee). Contrary to the common prior that securities lending is conducted at the fund family or lending agent level, we find rich heterogeneity in funds' lending strategies within these groups. We find that volume lenders generate higher lending revenue, allowing them to better offset fund expense ratios compared to value lenders. Notably, while volume lenders faced setbacks in cash collateral reinvestment during the 2007 financial crisis, recent data shows that value lenders have doubled their reinvestment into riskier assets, such as equities and bonds, and have strategically shifted within these assets to capitalize on the high interest rate environment post-2022.

Keywords: Mutual funds, Securities lending, Cash collateral reinvestment