Securities Lending

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me81
Posts: 29
Joined: Fri Jan 04, 2019 1:37 pm

Securities Lending

Post by me81 »

Hi all,

After listening to the much-recommended latest bogleheads podcast episode, featuring Vanguard Total Market Fund manager, I went digging a touch deeper into the securities lending practices of the two giants ETF providers.. I have a few points I would like people's opinion about:
  • iShares lists extremely transparently on the ETF webpage its securities lending practices (avg % on loan, max % on loan, collateral, returns, etc..). Having said that, it does show that IWDA has over 10% on average out on loan.. iShares gives 62.5% of its securities lending income to the fund and keeps 37.5% (again, very explicit and clear on the website). Blackrock also provides an indemnity to the fund, should the collateral fall below the value of the securities on loan and they failed to be returned. They state that in 40 years, only 3 times a borrower defaulted and never there has been a loss to the fund.
Q1: is that (and I believe I read they can loan up to 33.3% of the fund, though I doubt it ever happened) something to be concerned about?
Q2: does anyone know how if and how much of these returns offset the TER and/or provide an above market return?
  • Vanguard does not seem equally transparent. I could not find hard numbers on the website, but in the podcast and other web sources I read they limit their securities lending to a few % points. They also claim to give over 90% of the proceeds back to the fund.
Q3: is this a point in favour or against Vanguard (vs iShares)?

Q4: Lastly, if we engage in securities lending indirectly, would it make sense to enable IBKR Stock Yield Enhancement Program? I have so far stayed clear to avoid taking that risk, but wonder if I am instead just leaving money on the table.

Thanks all for your input and a couple of link (US-based, so not 100% accurate for non-US funds) for those interested.

Financial Times piece on ETF Securities Lending boom (2021)

iShares PDF explaining their practice

Cheers
AlohaJoe
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Re: Securities Lending

Post by AlohaJoe »

me81 wrote: Sun Sep 12, 2021 5:09 am Q1: is that (and I believe I read they can loan up to 33.3% of the fund, though I doubt it ever happened) something to be concerned about?
Dunno. I've never heard of any fund having problems with securities lending. The lending is fully collateralized, so it is hard to see how it could cause problems. But modern finance is full of things that seemed fine until they explode, so who knows?
Q2: does anyone know how if and how much of these returns offset the TER and/or provide an above market return?
It depends on the fund. In general broad market funds and large-cap funds don't make a lot from securities lending. Smaller funds tend to make more. Small cap funds frequently make at least as much from security lending as their expense ratio.

You can look in the the fund's annual report to see exactly how much they make and exactly how much they are spending on expenses.
Vanguard does not seem equally transparent. I could not find hard numbers on the website
Vanguard discloses all of this in the prospectus and/or statement of additional information.
Q3: is this a point in favour or against Vanguard (vs iShares)?
Nope.
Q4: Lastly, if we engage in securities lending indirectly, would it make sense to enable IBKR Stock Yield Enhancement Program? I have so far stayed clear to avoid taking that risk, but wonder if I am instead just leaving money on the table.
See above points about 1) how it is unlikely to make much money for broad-market index funds, 2) seems pretty safe due to collateral, 3) but modern finance is full of things that blew up unexpectedly that "everyone" thought were safe.

By doing securities lending directly you expose yourself to four possible problems: 1) if someone has borrowed the security when dividends are paid, you don't get a dividend, instead you get an interest payment that is taxed at a higher rate; 2) your account is subject to rehypothecation risk (which you can google); 3) someone you disagree with could borrow your shares and vote for ideas you hate; 4) short sellers will probably be borrowing your shares and maybe you hate short sellers.
renter
Posts: 393
Joined: Sat Aug 23, 2008 2:14 pm

Re: Securities Lending

Post by renter »

I had similar concerns and questions as the OP after listening to the bogleheads podcast featuring the index fund manager. I was left wondering if there are any stock index funds that do not practice securties lending altogether and if there are any, why did they make the decision, or if securities lending by stock index funds is universal. And what are the differences in the policies between VTSAX and a Fidelity Zero stock index fund and should we care if our life savings is tied up in such funds.
investorpeter
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Re: Securities Lending

Post by investorpeter »

I am not an expert in this area at all, but I recently signed up for the Fidelity Fully Paid Securities lending program, and it was well worth the minimal effort it took to sign up. I happened to have a stock that was in extremely high demand for borrowing (up to 64% annual rate for Lucid Motors - in anticipation of a price drop due to the PIPE investor lockup expiration). I only signed up with my IRA, so I would not have to deal with the potential tax consequences of cash in-lieu of divided payments. Just received my first monthly loan statement, and I am very glad I enrolled.

My understanding based on limited research from websites like this company that provides securities lending services to institutions (https://sharegain.com/funds/) is that most stocks in the SP500 are considered "general collateral" because they are easily borrowable and will only command borrow rates in the 10-30 basis point region. Still, that is significant enough to potentially compensate and more for ERs, but it seems likely this income is not consistent and cannot be relied upon. Potentially VTI would have more opportunities to earn income through stock lending since they hold smaller companies. It does seem to be a increasingly important source of income, and I am glad to see brokers like Fidelity opening this up to individual retain investors.
Topic Author
me81
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Joined: Fri Jan 04, 2019 1:37 pm

Re: Securities Lending

Post by me81 »

Thank you all for your input
But modern finance is full of things that seemed fine until they explode
that's exactly my issue.. After all, everything is quite "predictable" in normal times, but it is those unthinkable times that cause unpredictable events..
Vanguard discloses all of this in the prospectus and/or statement of additional information.
yeah, but it would be so much easier to have data in a similar way as iShares does, allowing even for year-on-year comparison, etc.. if one great advantage of ETFs and passive funds is their transparency, I think it would be fair to have securities lending data easily available, rather than hidden in some pdf file..
if there are any stock index funds that do not practice securities lending altogether
from what I could see, it is universal practice... and being one way funds have to make money outside of charging a management fee, I would guess that the cheaper the fund TER is, the more they try to make up in any other possible way...
in anticipation of a price drop
funny that is exactly one reason against allowing securities lending... it is clearly explained by IBKR: most stock lending goes to short-sellers, so basically you are lending your stock to someone who is pushing the price of that stock down...
how does Fidelity share the securities lending income? IBKR does a 50/50 split and also clearly states that they are the borrowers from you, and then they go on and do what they like with your share...
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asset_chaos
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Re: Securities Lending

Post by asset_chaos »

I started this thread on the securities lending income of Vanguard's small cap index funds.
For the 12 months as of December 31, 2019, the ratio of securities lending income to total expenses (as detailed in the OP) is

Small Cap 109%
Small Cap Growth 67%
Small Cap Value 77%
While the amount of securities lending income seems to vary a lot for these funds from year to year, yes, it sometimes does cover all the costs listed as expenses in the financial tables of annual report.
Regards, | | Guy
oogZoo
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Re: Securities Lending

Post by oogZoo »

renter wrote: Sun Sep 12, 2021 10:17 am I was left wondering if there are any stock index funds that do not practice securties lending altogether and if there are any, why did they make the decision, or if securities lending by stock index funds is universal.
SPDR MSCI World UCITS ETF (IE00BFY0GT14) does not do securities lending. That is the case with many other SPDR's passive UCITS ETFs also (but not all).
seajay
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Re: Securities Lending

Post by seajay »

AlohaJoe wrote: Sun Sep 12, 2021 7:42 amBy doing securities lending directly you expose yourself to four possible problems: 1) if someone has borrowed the security when dividends are paid, you don't get a dividend, instead you get an interest payment that is taxed at a higher rate;
Is that not the target benefit. Vanguard US might lend shares to Vanguard UK just prior to ex-dividend, and have them returned again upon going ex-dividend, as that is (made up, not sure if its the actual case) more tax efficient than if Vanguard US had received the dividend.
not logged in
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Re: Securities Lending

Post by not logged in »

seajay wrote: Tue Sep 14, 2021 3:51 am
AlohaJoe wrote: Sun Sep 12, 2021 7:42 amBy doing securities lending directly you expose yourself to four possible problems: 1) if someone has borrowed the security when dividends are paid, you don't get a dividend, instead you get an interest payment that is taxed at a higher rate;
Is that not the target benefit. Vanguard US might lend shares to Vanguard UK just prior to ex-dividend, and have them returned again upon going ex-dividend, as that is (made up, not sure if its the actual case) more tax efficient than if Vanguard US had received the dividend.
I don’t see how this is more tax efficient; to the contrary it seems less tax efficient.

For each loan Vanguard UK must pay Vanguard US an “in lieu of payment” (called a manufactured dividend in the UK) equal to the amount of the dividend paid on the loaned shares plus a lending fee. These amounts are taxed as ordinary income to Vanguard US (it is technically not interest because a securities loan is not indebtedness), rather than dividend income most of which would be QDI taxed at preferential rates when distributed to the shareholders Vanguard US (assuming it’s a mutual fund). Moreover a US withholding tax would be imposed on the dividends received by Vanguard UK. The net taxes would be increased by the amount of the US withholding taxes plus the greater taxes paid by the shareholders of Vanguard US on the distributions that otherwise would qualify as QDI but instead are taxed as ordinary income.
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