A Wall Street Journal article caught my eye today. Jason Zweig’s article “Is your Fund Pawning Shares at Your Expense?” covers a unknown regular occurrence that Mutual Fund Managers often loan out shares of the fund's stocks to other institutions. In the indexing world, this also occurs to help indexes cover expenses, and thus track the assigned index more efficiently. As I read the article, it seemed to me that the Mutual Fund managers are much more one sided in their tactics, and it is not on the side of the investor.
Borrowing from Mr. Zweig’s example, this securities lending is much like subletting your house except the fund will keep upwards of 50% of the funds earned from this lending practice. In some cases 100% of the money is kept by the fund manager, who is usually the lending agent for the transaction. Once these shares are lent out, the shareholders of the fund are at risk, not the fund advisor. An example of this risk of lending is the mutual fund Calamos Growth CNWGX. This fund took 475 million that it receives from lending securities and invested it in a money market that then purchased Lehman Brothers. The fund lost 8.6 million in the transaction, of which 100% is passed on to the fund's shareholders.
I agree with Mr. Zweig in that securities lending should take place and that nearly 100% of the proceeds should go to the investors, not the fund managers. I will note that here at Wiser Wealth, our iShares and Vanguard index funds do pass on the proceeds at the near 100% mark. This process is fairly transparent in indexing, but in the Mutual Fund world, it is less obvious as the current process of lending is not regulated by the government.
In my opinion, this is another case where the transparency of indexing is better for the individual investor.
Casey Smith - Wiser Wealth Management, Inc