"Fund groups challenged over securities lending practices"

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AlohaJoe
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"Fund groups challenged over securities lending practices"

Post by AlohaJoe » Mon May 13, 2019 9:36 pm

(This is a Financial Times article, you need to have a free account to read it.)

https://www.ft.com/content/62946b2e-1a3 ... 8dfda43b2a
BlackRock, UBS Asset Management and Deka have been challenged on the revenues generated by their securities lending activities, reigniting a debate about an opaque but lucrative part of the fund industry.
Apparently in 2012 the EU passed a rule saying asset managers aren't allowed to profit off on securities lending -- investors have to receive all securities lending revenue. I didn't know that! But there are questions about how much this is being followed in practice.

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In its analysis, Better Finance found that Vanguard investors receive almost double the amount of gross revenue that Deka investors do. Vanguard pays 95 per cent of gross income to investors, while Deka returns 51 per cent. This means that Deka retains almost 10 times more gross income than Vanguard to cover costs.

“We do not understand how asset managers can have costs as a proportion of revenues that vary from one to 10,” Mr Prache said.
After that is a bunch of excuses from BlackRock, Deka, UBS, State Street and others about why they fare so poorly in the report.

While I do hold fund from non-Vanguard providers, things like this seem like another bit of evidence about Vanguard being aligned with investors in ways that most other providers simply aren't.

Random Walker
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Re: "Fund groups challenged over securities lending practices"

Post by Random Walker » Mon May 13, 2019 10:21 pm

Think I’ve read something about it being good for investors if securities lending revenue is limited to the amount of the expense ratio. Does anyone understand that? Is it some sort of tax issue? Thanks,

Dave

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JoMoney
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Re: "Fund groups challenged over securities lending practices"

Post by JoMoney » Mon May 13, 2019 11:40 pm

Random Walker wrote:
Mon May 13, 2019 10:21 pm
Think I’ve read something about it being good for investors if securities lending revenue is limited to the amount of the expense ratio. Does anyone understand that? Is it some sort of tax issue? Thanks,

Dave
Never heard that before, hard to imagine why it should have any relationship to the funds expense ratio at all. I suppose that in the specific case of index funds, where the object is to track an index, it would fail to meet that objective if the funds return was regularly higher by more than a few basis points above the ER.
Securities lending might generate some income that's not qualified dividend, but if it's increasing the return with negligible risk... hard to imagine people would turn that down.
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

272 Sheep
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Re: "Fund groups challenged over securities lending practices"

Post by 272 Sheep » Tue May 14, 2019 9:33 am

I interpret it like this:
1, Vanguard returns 95% of securities lending back to shareholders.
2. Maybe, costs Vanguard 5% to do it.
Sure looks like it is consistent with, that Vanguard is aligned with shareholder interests, (much) more so than those others are.
Was it Morningstar that gave Vanguard best fiduciary award?

adamthesmythe
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Re: "Fund groups challenged over securities lending practices"

Post by adamthesmythe » Tue May 14, 2019 10:02 am

> “We do not understand how asset managers can have costs as a proportion of revenues that vary from one to 10,” Mr Prache said.

Not surprised at all. Maybe they hire the accountants who, when asked what 1 + 2 is, answer, what would you like it to be?

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jhfenton
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Re: "Fund groups challenged over securities lending practices"

Post by jhfenton » Tue May 14, 2019 1:16 pm

Random Walker wrote:
Mon May 13, 2019 10:21 pm
Think I’ve read something about it being good for investors if securities lending revenue is limited to the amount of the expense ratio. Does anyone understand that? Is it some sort of tax issue? Thanks,
That doesn't make any sense to me and is certainly not the case for many small cap funds. VSS/Vanguard FTSE All-World ex-US Small Cap ETF has outperformed its benchmark by 49 bp annually over the trailing 3 years and 18 bp annual over the last 5 years. (It trails its benchmark by 7 bp over the trailing 10 years.) As the fund has grown and its expenses have dropped, its securities lending revenue--which is naturally higher for less available small cap stocks--has started to outstrip its expense ratio.

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Nate79
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Re: "Fund groups challenged over securities lending practices"

Post by Nate79 » Tue May 14, 2019 2:33 pm

The Blackrock S&P500 fund in my 401k has lower expenses than the Vanguard equivalent and has both outperformed the benchmark and the Vanguard fund. Fund family generalizations don't seem that useful and most importance is performance vs the benchmark.

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jeffyscott
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Re: "Fund groups challenged over securities lending practices"

Post by jeffyscott » Tue May 14, 2019 4:46 pm

Morningstar article here:
https://www.morningstar.com/articles/90 ... -lend.html

Says: Some firms with less generous splits consistently generate more total lending revenue by lending more aggressively.

Is it possible that it costs more to be more aggressive in finding lending opportunities?
Time is your friend; impulse is your enemy. - John C. Bogle

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JoMoney
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Re: "Fund groups challenged over securities lending practices"

Post by JoMoney » Tue May 14, 2019 8:53 pm

jeffyscott wrote:
Tue May 14, 2019 4:46 pm
Morningstar article here:
https://www.morningstar.com/articles/90 ... -lend.html

Says: Some firms with less generous splits consistently generate more total lending revenue by lending more aggressively.

Is it possible that it costs more to be more aggressive in finding lending opportunities?
That seems weird, I would expect that it's usually borrowers seeking out brokerages with shares available for lending, not lending desks calling around to see who wants to borrow... But they might possibly be allowing the collateral to be in more "aggressive" (risky) investments and earning more interest on the collateral while the shares are being borrowed.
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

retiringwhen
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Re: "Fund groups challenged over securities lending practices"

Post by retiringwhen » Tue May 14, 2019 9:01 pm

JoMoney wrote:
Tue May 14, 2019 8:53 pm
jeffyscott wrote:
Tue May 14, 2019 4:46 pm
Morningstar article here:
https://www.morningstar.com/articles/90 ... -lend.html

Says: Some firms with less generous splits consistently generate more total lending revenue by lending more aggressively.

Is it possible that it costs more to be more aggressive in finding lending opportunities?
That seems weird, I would expect that it's usually borrowers seeking out brokerages with shares available for lending, not lending desks calling around to see who wants to borrow... But they might possibly be allowing the collateral to be in more "aggressive" (risky) investments and earning more interest on the collateral while the shares are being borrowed.
I remember reading somewhere that Vanguard does not go for the lower-margin securities lending in part because they believe it is riskier, they instead focus on the easy money in lightly traded (mostly small cap stocks) where margins are higher.

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jeffyscott
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Re: "Fund groups challenged over securities lending practices"

Post by jeffyscott » Tue May 14, 2019 9:34 pm

retiringwhen wrote:
Tue May 14, 2019 9:01 pm
JoMoney wrote:
Tue May 14, 2019 8:53 pm
jeffyscott wrote:
Tue May 14, 2019 4:46 pm
Morningstar article here:
https://www.morningstar.com/articles/90 ... -lend.html

Says: Some firms with less generous splits consistently generate more total lending revenue by lending more aggressively.

Is it possible that it costs more to be more aggressive in finding lending opportunities?
That seems weird, I would expect that it's usually borrowers seeking out brokerages with shares available for lending, not lending desks calling around to see who wants to borrow... But they might possibly be allowing the collateral to be in more "aggressive" (risky) investments and earning more interest on the collateral while the shares are being borrowed.
I remember reading somewhere that Vanguard does not go for the lower-margin securities lending in part because they believe it is riskier, they instead focus on the easy money in lightly traded (mostly small cap stocks) where margins are higher.
Yeah, it could mean being more aggressive in that way, lending even the low margin ones and thus generating more total revenue, even though it costs more to do that.

I didn't think it could be the investments being more "aggressive", at least currently, as the article states: Today, nearly the entire cash collateral portfolio must be invested in U.S. Treasuries or short-term commercial paper rated AA or higher.
Time is your friend; impulse is your enemy. - John C. Bogle

pdavi21
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Re: "Fund groups challenged over securities lending practices"

Post by pdavi21 » Tue May 14, 2019 10:07 pm

I thought Vanguard returned 100% of lending revenue. Is the remaining 5% expenses associated with securities lending?
"We spend a great deal of time studying history, which, let's face it, is mostly the history of stupidity." -Stephen Hawking

retiringwhen
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Re: "Fund groups challenged over securities lending practices"

Post by retiringwhen » Tue May 14, 2019 10:24 pm

For those wondering how Vanguard gives back 95% and many others give back much less. I believe it boils down to two things:

1.) Value strategy vs. Volume Strategy - Vanguard targets lending on the high margin hard to find securities that have very high profit margins (250 bps). Many other funds go for Volume (think MegaCaps/S&P500) where the profit margins are 1/10th (20bps)

2.) Vanguard acts as its own lending agent at least in the USA and does not share revenue with the Fund. So 100% of revenue is returned to the fund. Other companies either use 3rd parties that require fee or operate their own agent that takes a fee for the house.

This paper (the one I remembered above) goes into great detail of the Securities Lending environment in the industry and Vanguard's approach in particular.

Here is the punch line on Vanguards approach. The difference in margins is pretty clearly laid out....
https://personal.vanguard.com/pdf/ISGSL.pdf wrote: Two lending strategies: Value and volume

Securities-lending strategies can be characterized as either value or volume lending.

Value lending, also known as intrinsic-value lending, seeks to capture a scarcity premium by lending hard-to-borrow securities, or “specials.” The scarcity premiums provide the lender with a high return per dollar of securities lent, though with fewer opportunities to lend. In volume lending, also known as general collateral lending, the owner seeks to lend many securities, independent of scarcity value. Per-loan fees are lower, but there are
more opportunities to lend.

In 2015, general collateral loans—some 80% of global loans by volume—generated annualized lending fees of 20 basis points (0.20%) or less. The most valuable specials, by contrast, represented just 4.4% of loan volume, but commanded fees of 250 basis points or more. These loans accounted for 62% of the gross fees from securities lending in 2015.
Vanguard’s approach to securities lending Vanguard serves as the lending agent for the Vanguard funds’ securities-lending program in the United States. Outside the United States, Vanguard works with an independent lending agent. Vanguard funds do not lend fixed income securities.

All Vanguard portfolios—mutual funds, UCITS (Undertakings for Collective Investment in Transferable Securities), OEICs (Open-Ended Investment Companies)—follow the same policies and risk constraints.

Our program seeks to capture the scarcity premium found in hard-to-borrow securities. We minimize risk in the reinvestment of cash collateral by investing in a money market fund managed by Vanguard Fixed Income Group. The fund’s average weighted maturity is capped at 60 days.

Outside the United States, Vanguard accepts sovereign debt as non-cash collateral and invests any cash collateral in overnight repurchase agreements, subject to daily monitoring by Vanguard’s Risk Management Group. Vanguard has developed a monitoring program and lending limits for individual securities to ensure that any securities on loan can be recalled for important proxy votes.

To reduce the risk of counterparty default, Vanguard lends to a limited number of pre-approved broker-dealers and maintains strict internal guidelines on the aggregate dollar amount of loans to any one borrower. In addition, Vanguard ensures proper collateral coverage by valuing the loaned securities on a daily basis—using current market prices—and by calling for additional collateral when necessary to bring the coverage up to the 102% or 105% floors for U.S. or foreign securities, respectively. Vanguard’s agency agreement requires the lending agent to indemnify our fund in the case of a counterparty default by replacing either the security or the security’s current market value to the fund.

Consistent with Vanguard’s client-owned structure, Vanguard returns all net lending revenues—after subtracting program costs, agent fees (on non-U.S. securities), and any broker rebates—to the funds. In 2015, program costs amounted to about 5% of gross revenue.

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