Who’s been sleeping in my bed? Shocking stuff on stock lending.


Imagine you have to put your furniture in storage, white goods, carpets, chairs – the lot.

You nip off abroad for a couple of years and return to find your furniture still there, you pay your storage charges and take the stuff back.

Nothing wrong with that! But then you get a call from a friend saying how much he enjoyed using your furniture last year. Nonplussed you phone the storage firm who point out that in the small print , it has the right to lend your furniture and make a nice turn on it. They point out that you got it back in as good a nick as you left it so what are you worried about

Fine , you say, but you were lending my property and I want my share of the proceeds. Reluctantly money is returned, offsetting the storage fees but not all of it.

You think to yourself, this is pretty shoddy stuff. There ought to be a bit more said about this. There ought to be a cap on the amount these firms keep for doing this work and I ought to be told when it’s gone on so I don’t get ripped off. You’d be right.

Of course, storage companies do not lend out your property, but fund managers do!

You give them money, they give you a slip telling you how many units in their fund you own, they then buy assets which they can lend to others for profit. As the beneficial owner of the returns of the fund, you would expect to be getting the lion’s share of the profits from this lending and not to see it being trousered by the fund manager.

You would not expect the money to be lent to hoodlums or terrorists, but in a financial sense that is often what happens. In America, where scrutiny of fund managers “fiduciary obligations” is much stronger, pressure has mounted on firms when they lend , to lend wisely and firms are responding. Thanks to Michael Glenister of Investment Circle for this;

Speaking at a Select Committee meeting held by the UK government’s Department for Business Innovation and Skills (BIS) this week, Dominic Rossi, the firm’s global Chief Investment Officer said his firm already did very little stock loan because it does not want to lend to borrowers that want to short the stock. (Citywire http://tinyurl.com/ac6ow52)

There is risk- like your furniture, your assets could get nicked or lost, that risk needs to be insured and there are legal costs and sales costs . We would expect that whoever organises the stock lending would pick up the costs and bear the risks out of the profit of the enterprise. I’d expect a storage company to be acting for me in trying to keep those costs low.

And when  I think this through, I’d want an agreement with my fund manager, as I would with my storage company, that I would be entitled to a minimum percentage of the profits after fees had been deducted. Those who remember back to with-profits will remember 90:10 funds will remember the policyholder got 90% of the profit after the deduction of costs- put another way, the lower the costs the better for insurer and policyholder- an alignment of interests not in place today.

I wouldn’t expect them to cancel out my storage charge but I’d like them to make a dent in them. Indeed, if I could see that one storage company could show me their track record in reducing costs, I’d favour them (all else being equal).

As for funds, we don’t have a clue how our fund managers work. Well we sort of do if we read excellent articles like this from Emma Dunkley http://tinyurl.com/ambsyh2

Emma has found much confusion about who is doing what. Organisations like Black Rock and State Street are withholding as much as 40% of the profits of their stock lending to keep their profits up and managers in bonuses. Other firms, Vanguard most notably , rebate all the profit. In the States, Black Rock are being sued by angry investors pointing out that Black Rock’s slice of the cake is exorbitant. There is a growing body of research in the US that demonstrates just how good practice in stock lending leads to better returns

I expect that Black Rock will point to some legal point that demonstrates they can do what they want. But they will lose that argument. When you give money to a fund manager, they agree to act as your agent and are subject to fiduciary obligations – that’s why so many of them have in their titles words such as “Fidelity and Prudential”, their brand is about “care”.

The good news is that the Regulators are catching up

The European Securities and Markets Authority (Esma) guidelines on exchange traded funds (ETFs) and other Ucits issues, which came into effect on 18 February, require Ucits products engaging in securities lending to return all revenues, net of operating costs, back to the fund. http://tinyurl.com/ambsyh2

But there are still opportunities for the perseverant opportunist running a fund. The definition of “costs” is far from clear, (the bloke running the storage company could sub his insurance to Acme brokers and be pocketing a 50% commission rebate). Worse still he could have set up his own management company and be charging his customers whatever he thought reasonable.

stock lending

And this is where I get to do some hand clapping. There are people out there who are sharp enough to know about these things, diligent enough to bring them to our attention and brave enough not to get shouted down by the institutions who do not want any honesty about what is going on.

Step forward Alan Miller who posted most of the information I am using onto the Pension Play Pen, step forward Terry Smith whose fund Fundsmith is pioneering new standards of openness and step forwards too, the journalists who are investigating these difficult subjects and bringing the information to our attention.

The knowledge we are gaining about matters such as stock lending, helps people like me, who’s job it is to chose the funds that carry our retirement dreams, to chose wisely and act as trustees or advisers ensuring their is no slippage. This is proper fund governance there is not enough about and we are miles behind the Americans on much of this.

Meanwhile , academics like David Blake and Dr Debbie Harrison at Cass Business School are also catching up, working out what good looks like and feeding into their models the information that the likes of Emma Dunkley and Michael Glenister are rooting out.

David told the OPDU conference last week that fund charges have a bigger influence on the amount of pensions we get , knocking asset allocation off that perch. At First Actuarial, we model the impact of fractional differences in charges and quite agree. No matter how skilled a fund manager, if he hasn’t got his charges under control, he cannot add value.

And whether it’s a Professor, a journalist, an adviser or a consumer champion, the message is the same. If we are to move forward and make pensions clean and respected, it’s at this level of scrutiny that we translate fine words into action.

As Emma did, I will let Alan Miller have the final word

‘Esma needs to show BlackRock that even though they are a big player this does not prevent them from following the spirit of the rules and if necessary BlackRock’s ETFs and other funds involved in securities lending should be banned by Esma in describing themselves as UCITS funds,’

About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
This entry was posted in dc pensions, Fiduciary Management, Financial Education, First Actuarial, NEST, pension playpen, pensions, stock lending and tagged , , , , , , , , , . Bookmark the permalink.

9 Responses to Who’s been sleeping in my bed? Shocking stuff on stock lending.

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  4. Thoughtful article, Henry !

    Please permit me to turn the key on the sardine tin a little further as the issue of stock-lending can apply to segregated as well as pooled mandates – this time it is generally the scheme’s custodian that likes to promote stock-lending as a value-add service.

    The historic rationale for splitting revenues was that the scheme provides the raw stock and permitted the custodian / manager to defray their costs in running the program. However, a stock-lending program is an economy of scale thing which can be run over multiple clients and 2008 taught us that the risks in stock-lending live with the scheme …

    I would treat ‘destination of any stock-lending revenues’ as one of the important due diligence questions when selecting funds (or custodians) and I wouldn’t hesitate to complain directly to a manager (or the fund directors / trustees) if they had a policy that we felt wasn’t appropriate.

    Veasey Associates Ltd

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