Investors lending ETF units shave further 40% off fees

ETF investors engaged in securities lending shaved a further 40 per cent off already-squeezed fees over the last year and in some cases even make a net profit, a new report reveals.

Most investors associate ETF lending with “inside” activities, whereby the underlying securities are lent to the benefit of all investors; but a Markit report notes that “outside” activities, where individual investors lend ETF units can provide an additional source of income.

Revenues from lending ETF units can often outweigh lending underlying assets due to stronger demand than supply, Markit research analyst Simon Colvin argues.

Only 5 per cent of total ETF AUM sits in lending programs compared to over a quarter of the Russell 3000 market cap.

Motivations for borrowing ETF units include hedging assets tracked by an ETF and market making activity in the funds themselves. There is also a growing lists of derivatives that track them.

ETF lending over the last 12 months earned $417m allowing investors to recoup 40 per cent of costs through lending their assets, the report notes.

Some investors were able to offset the higher cost of fees for different products as lending fees can vary by product, even if they track the same assets.

For example, high yield ETF investors would make 73bps from the iShares iBoxx $ High Yield Corporate Bond ETF, but only 23bps from the SPDR Barclays High Yield Bond ETF even though they track the same assets.

Investors in the former would make a net 23bps from lending even though its fees are more at 50bps. For the latter, however, returns from lending would only reduce the 40bps fee to 17bps.

The implications are significant for an asset class where fees are a major driver of investment inflows.

The iShares ETF is one of 151 ETF products have earned more for their investors than the total cost of fees. Most of these products are in the US where the market is more mature, but 17 were in Europe and European listed ETF lending revenue increased 15 per cent year on year in Q1.

10 largest revenue generating ETFs amassing one-third of all revenues

Colvin notes ETFs that generated the most fees from securities lending over the last 12 months are very diverse in terms of exposures.

“They include heavily traded mega-S&P 500 funds, funds which track hard to short asset classes such as high yield bonds and emerging market equities, and those that track relatively volatile asset classes like small cap stocks and biotechs,” Colvin says.

The SPDR S&P Biotech ETF would return investors 76bps on top of fees, while the iShares Russell 2000 and MSCI Mexico Capped ETFs would also deliver returns that more than compensate fund fees.