Securities lending in ETF, what the?

DrSyn

newbinvestor wrote: »

Some of the funds I was looking at ,for example IShares MSCI Japan IMI ETF seem to have around 20% of the AUM as loans, my gut is saying to avoid these for now.

As I understand it, Vanguard securities lending on their passive funds is capped at about 7.5%. Normal level is around 2%.

They say they only lend on the hard to get hold of securities as they can charge a higher fee for this.

While HSBC Global Strategy funds do no securities lending at all.

[Deleted User]

Of the iShares ETFs I was going to buy, most seemed to have an "average on loan" % of around 5%, and a few had high ones like this of 20.93%, maximum 35.93%

https://www.ishares.com/uk/individual/en/products/251867/ishares-msci-japan-ucits-etf-acc-fund

Aminatidi

One of the reasons I have, to date, steered clear of ETFs is because they don't seem as transparent as OEICs and Investment Trusts.

I quite like that a board oversees and Investment Trust.

I always feel, rightly or wrongly, that ETFs will end up being a bad place to be when the algorithm's go into some mad automated death spiral.

Brian65

Aminatidi wrote: »

I quite like that a board oversees and Investment Trust.

Like Woodford Patient Capital Trust?
You can't eliminate risk altogether, only minimise it.

horace972897

I wonder if (the royal) "we" have been looking into this since Terry Smith made his comments as reported on Monevator recently?


I have also been looking into ETF's and securities lending and have been mildly concerned that a lot of ETF's that I was under the impression were Physical (albeit using sampling) also have variations on the following texts about using derivatives and other financial instruments (even FTSE 100 Trackers that should be able to track physically very easily)


e.g. The Fund may invest in financial derivative instruments that could increase
or reduce exposure to underlying assets and result in greater fluctuations
of the Fund's net asset value. Some derivatives give rise to increased
potential for loss where the Fund's counterparty defaults in meeting its
payment obligations.


or



The Fund may gain exposure to the shares in the index using
other investments such as derivatives or other funds.


or


The investment manager may use financial derivative instruments (FDIs) (i.e. investments the prices of which are based on one or more underlying assets) to help
achieve the Fund’s investment objective. FDIs may be used for direct investment purposes. The use of FDIs is expected to be limited for this Share Class.


Thought's anyone?

bowlhead99

Market trackers, whether ETF or fully open-ended, compete with each other on price while trying to deliver close to what the underlying index returns. Periodically the index components change or the size of the fund changes due to new investors or departing investors. It can be efficient to temporarily buy a piece of another fund or a total return swap or some other derivative instead of buying the underlying holding or set of holdings, to get the exposure desired.

For indexes which track a larger number of holdings, they may use a sampled/ optimised approach which doesn't hold exactly the same as the index but hopefully gets basically the same result.

Many funds will use derivatives to a limited extent to achieve their goals. As the funds need to tell the investors that they might do this, they will put some catch-all language into their documentation.

Unfortunately even if they are only trying to cover themselves for sporadic and limited use, they still need to put the language in and make it sound like they could be doing however much of it as they like, so that the investors are aware of it; and phrasing like 'the use is expected to be limited' does not really help, other than if they end up with a 50% synthetic fund they would expect to get some complaints because the lay person would think that's more than 'limited use' (even though technically it is more limited than 'unlimited use'...

If you are Terry Smith and you are only going to buy a small number of companies with many millions in each of them, to a target allocation which you make up in your head and change from time to time, you are not worrying about hitting a specific target return (e.g. the return of x.xxx% Shell and y.yyyy% HSBC etc etc). Your fund investors are less cost-conscious and are not looking for your returns to be within a few basis points of a benchmark, so you can be more relaxed about it, and as you build your stakes in each new position over a period of time, there is no need to use derivatives and get instant exposure regardless of market conditions.

In Terry's case, part of your marketing might then be to say the lack of derivatives is a selling point and that you are an honest straight talker and your fund does what it says on the tin, no smoke and mirrors etc etc. It does not mean that the rival for your customer's money - an index fund which used a few derivatives here or there - is going to give a particularly 'unsafe' or 'unreliable' result. The Smith fund is already an unreliable result because it gets the result of whatever companies Smith cherry-picks, rather than whatever the average of companies would offer. It's safe from losing a percent to counterparty risk, but has greater investment risk because of being more concentrated into fewer investments.

Making your fund sound better than other alternative investment products (whether that's through talking up your stockpicking skills or talking down the rival's riskier underlying holdings) is something that active fund managers specialise at.

[Deleted User]

I have looked at the iShares annual reports of the ETFs (physical, optimised) and there was nothing that worried me about them or the holdings. The holdings were all clearly marked out and in the right weightings, it did restore some of my confidence in them. Still overall, I do prefer funds, but ETFs have cheaper platform fees (£45 with Fidelity). Decisions, decisions.

bowlhead99

newbinvestor wrote: »

The holdings were all clearly marked out and in the right weightings, it did restore some of my confidence in them. Still overall, I do prefer funds, but ETFs have cheaper platform fees (£45 with Fidelity). Decisions, decisions.

Funds which track indexes (as distinct from ETFs that track indexes) will also generally have catch-all language about being allowed to use derivatives.

It is a feature of many tracker products that they are just going to be sitting there with a lot of shares doing nothing all year, so they might seek to cover some of their costs of operations by lending the stock out (against appropriate collateral) and try do a better / cheaper job of keeping up with the result of the index by using derivatives around the place. So it's always good to have a look 'under the hood' and ask questions about how they achieve their good performance.

Kentish_Dave

What’s the actual concern around securities lending?

bowlhead99

Kentish_Dave wrote: »

What’s the actual concern around securities lending?

That the people to whom you lend the securities, may not be able to give it you back; then, even if you get to keep their collateral, it may change in value differently from how the securities change in value, before you can cash it in and re-acquire the securities that you originally held.

Similarly the OP is concerned about use of derivatives because anything you buy which has a value derived from a particular security or index of securities (without being the security itself) requires you to have an agreement with a counterparty to the deal; and what if the counterparty cannot or does not keep their end of the bargain.