It was only a matter of time.
Vanguard is introducing securities lending to Australian ETFs, bringing the Aussie ETF market up to speed with the rest of the world.
Described as the “best kept secret” in the ETF industry, securities lending is where ETF providers lend out the shares owned by their funds to short-sellers. Short sellers then pay rental fees, which are taken as additional income or used to white ant management fees.
“[Our] approach is a value approach. We look for securities that are in high demand in the market and then lend those securities,” said Jane Wagner, Global Head of Securities Lending at Vanguard, in an advisor education video recently uploaded on YouTube.
“We end up only lending out a small proportion of the portfolio and end up generating some nice revenue.”
All the gains of securities lending will be given to investors, Vanguard have said. There will be no “fee split” – where the fund takes a slice of the rental yield. The lending will be overseen by JP Morgan, who will act as the lending agent.
While securities lending is very common in the US and Europe, Aussie ETF providers have fought shy of lending out their holdings.
The reluctance has largely owed to lack of scale. In order to be profitable, lending volumes typically have to be in the hundreds of millions. This is because securities lending is competitive and rental fees are correspondingly quite low. By Vanguard’s own estimates, yields will be 10 basis points per fund on average.
Uptake has also been sluggish due to investor perceptions of risk. Particularly, that borrowers may fail to return borrowed securities.
In order to see off this risk, Vanguard will evaluate every borrower to ensure they’re credit-worthy. The group will also restrict the amount of stuff a single borrower can take. While borrowers will be required to post high quality collateral worth 102% of whatever they borrow.
As an additional measure, Vanguard has put in place an agency agreement requiring JP Morgan to indemnify their funds in the case of a borrower default. (Such an agreement would presumably block rehypothecation).
To deal with negative investor perceptions, the company kicked off a marketing campaign aimed at spelling out its risk-control methods as well as advertising the benefits. The campaign has included a white paper, video and articles.
Chris Brycki, CEO of Stockspot, a Sydney-based robo-advisor which uses Vanguard ETFs, said the move was potentially a good thing, but he wanted to wait to find out more.
“Securities lending has its risks however it can benefit ETF investors over the long run provided the counterparty risks are carefully managed and the benefits are passed on to the end investor.
“I’ll be watching to see what benefit it provides investors across various asset classes relative to Vanguard fund fees.
“Hopefully this move by Vanguard doesn’t lead to other ETF providers taking higher lending risk in order to remain competitive and retain lending revenues for themselves. If this starts to happen investors in those funds may not be getting fairly compensated for higher lending risks.”