Securities Lending

Securities lending is when an ETF or mutual fund temporarily lends its stock or bond holdings to another party — usually a broker-dealer or hedge fund that needs to borrow shares for short selling. The borrower provides collateral (cash or securities) and pays a lending fee. This income can offset the fund's expense ratio.

How Securities Lending Works:

1. Borrower (short seller) requests shares from the fund
2. Fund transfers shares to borrower
3. Borrower provides collateral (typically 102-105% of share value)
4. Borrower pays daily lending fee
5. Fund invests collateral and earns additional return
6. When borrower returns shares, collateral is returned

Who Borrows and Why:

• Short sellers — borrow shares to sell, hoping to buy back cheaper
• Market makers — borrow to settle trades and provide liquidity
• Arbitrageurs — borrow for hedging strategies

Revenue Sharing:

Fund Family	Fund Keeps	Manager Keeps
Vanguard	100%	0%
iShares/BlackRock	~62%	~38%
SPDR/State Street	~85%	~15%

How Much Income?

• Most large-cap stock ETFs: 0.01%–0.05% annually
• Small-cap/hard-to-borrow stocks: 0.10%–1.00%+
• This can partially or fully offset the expense ratio

Risks:

1. Counterparty risk — borrower may default (mitigated by over-collateralization)
2. Collateral reinvestment risk — cash collateral invested in short-term securities
3. Recall risk — fund may need shares back when borrower can't return them
4. Voting rights — lending fund loses voting rights on lent shares

Impact on ETF Returns: Securities lending income can make some ETFs outperform their index after fees. For example, a 0.03% expense ratio ETF earning 0.04% from lending effectively has a negative expense ratio.