IWM has a 0.20% expense ratio, TWOK has a 0.12% expense ratio and VB has a 0.09% expense ratio, so securities lending activity appears quite robust to compensate for ETF fees and beyond.
Securities lending is a practice where mutual funds and ETFs pay agents to lend out shares in their portfolios – the funds represent a basket of securities – to other traders and thereby earn interest.
The holder temporarily transfers the security to another investor in exchange for collateral, such as cash or other securities equal to 102% to 105% on of the shares’ value. If the ETF needs to sell stock, it can take it out of the borrower. If the borrower is unable to deliver the shares, the ETF uses the collateral.
In most cases, ETFs would lend securities to investors who want to short a stock. The investors would have to borrow shares from the provider and sell them on the market, hoping that when it comes time to give the shares back, they would be able to repurchase shares at a lower price in the market and pocket the spread.
However, securities lending has been associated with counterparty risk. If a borrower, for whatever reason, does not return the shares, the ETF would be left in a short squeeze.
On the provider side, ETF sponsors usually receive collateral in the form of cash or other securities. Consequently, fund companies can reinvest the cash or lend out the securities, but they usually steer toward conservative bets like short-duration, low-risk assets. However, other fund providers may invest collateral in overly risky instruments, leaving investors at risk. Some providers, though, compensate their ETFs in case of losses due to share lending.
Max Chen contributed to this article.