Friday, September 22, 2023 - Exchange-traded funds (ETFs) in the cryptocurrency, cannabis, and clean energy sectors experienced significant lending revenues last year, despite substantial losses due to poor market performance. The most lucrative lending returns were linked to the least popular stocks on the market, leaving investors in a challenging position.
Securities lending, a practice where ETFs lend out their held securities to traders such as hedge funds looking to short stocks, typically provides minor additional revenue for ETFs and mutual funds. However, in 2021, certain niche US thematic funds obtained unusually high fees from stock lending.
The Invesco Alerian Galaxy Crypto Economy ETF led the pack with revenues equivalent to 3.2% of its assets from securities lending last year, equating to 524% of its net expense ratio. The Global X Cannabis ETF and the VanEck Digital Transformation ETF followed closely with revenues of 2.87% and 2.81% respectively.
These three ETFs experienced losses between 67% and 85% last year due to poor market performance in the crypto and cannabis sectors. This attracted short sellers who borrowed shares to circumvent SEC-imposed short-selling time limits.
Morningstar identified 20 US-listed ETFs that received lending revenues of at least 0.59% of their assets last year. The list was heavily skewed towards digital assets and technology sectors that were most affected by the market crash. Only one fund on this list, iShares Interest Rate Hedged High Yield Bond ETF, managed to outperform the Morningstar US Market Index's decline of 19.4%.
Invesco was a significant player in this space, with five of the top 10 ETFs lending revenue as a percentage of assets. According to Anna Paglia, global head of ETFs and indexed strategies at Invesco, the firm returned more than $100 million to fund investors in lending revenues last year.
Despite these high revenues, lending earnings for larger, mainstream funds were typically more modest. The average Vanguard fund received just 2.31 basis points of revenue last year, while the typical BlackRock (NYSE:BLK) or iShares fund received 2.12 basis points.
Vanguard distinguished itself by passing 97% of the securities lending revenue to its investors from February 2022 to June 2023, ahead of SSGA's 79.1%, Invesco's 77%, and BlackRock/iShares' 74.5%.
Regulations have tightened around disclosure, collateral, and cash reinvestment since the global financial crisis, making securities lending safer than ever before. However, investors are advised not to let these revenues influence their overall asset allocation decisions.
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