The ETF industry has long engaged in securities lending as a way to generate extra cash, but some investors have grown wary of the practice, arguing that the risks don’t justify benefits.
Securities lending is a practice where mutual funds and ETFs pay agents to lend out shares in their portfolios – the funds are created with exposure to an underlying basket of securities – to other traders and thereby earn interest.
ETF providers would typically 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.
For the ETF provider, securities lending can generate extra returns, which issuers argue can help reduce management fees and even enhance an ETF’s overall performance.
However, some ETF investors are concerned that the process of loaning out these underlying securities also comes with undue risks, especially during volatile conditions or market downturns, the Financial Times reports.
“It does add an extra level of complexity to otherwise plain vanilla trackers or ETFs and could add to the risks in periods of market shocks,” Ben Seager-Scott, chief investment strategist at the Tilney Group, told the Financial Times.