Investors take issue with ETF loan fees Operators of exchange traded funds are making increasing sums of money by lending securities to short-sellers in return for cash or collateral as the funds surge in popularity. Concern is growing among investors at the differences in how much of that revenue is returned to investors and how much is retained by operators, such as BlackRock and Vanguard. Financial Times research shows the share of revenue retained by operators varies from 5 per cent to 50 per cent. "I knew issuers lent out securities, but I'm shocked by how much of the revenue some are keeping back," said Bryce James, an investment adviser at Seattle-based Smart Portfolios, which invests client money exclusively through ETFs. It affects the cost and benefits of choosing a fund. ETFs, which passively track indices such as the S&P 500 by buying underlying stocks, have accumulated large portfolios of securities as their assets under management have doubled to almost $1.8tn since 2007. Operators routinely lend the funds" securities in return for cash payments, or collateral, which can be reinvested elsewhere to generate additional returns, a practice also common among mutual funds. BlackRock generated $164m by lending securities owned by the US-listed ETFs of its iShares franchise in the past fiscal year. BlackRock retained $57m, or 35 per cent, in fees. State Street keeps 15 per cent of the revenue generated by lending the securities of its SPDR funds unit, the second-largest global ETF provider by assets after iShares. These so-called revenue "splits" have drawn criticism from smaller operators. "Some providers take a portion of the lending revenue, some up to 40 per cent," said John Woerth at Vanguard. Would the investor give up 40 per cent of, say, Apple's share price gain? Mr Woerth said Vanguard, an investor-owned company that seeks to operate at cost, returned at least 95 per cent of securities lending revenue to investors in its ETF unit. SPDR said State Street required similar revenue splits from its external securities lending clients, while BlackRock said its fees were justified by strong returns. "Splits do not tell the whole story on securities lending," said David Lonergan, managing director at BlackRock. BlackRock has generated more revenue for shareholders on an after-split basis. The variation in practice has emerged because of limited disclosure requirements. In the US, which accounts for more than half of global ETF assets, operators must tell investors if they plan to lend out securities but are not required to disclose revenue or fees. While BlackRock and State Street publish fees in their funds" annual reports, Vanguard does not. Van Eck and PowerShares, who appoint external banks to administer their lending programmes, said they return all revenue to investors but declined to say what share is retained by the agents in fees. "Investors should be able to see all the costs and revenue sources involved in an ETF but it can be hard to obtain that data," said Deborah Fuhr, a partner in London-based ETF Global Insight. Fee splits and disclosure may be less favourable to investors in non-US funds. Both BlackRock and State Street retain 40 per cent of securities lending revenue from their European-listed funds while Nomura, the Japanese bank, retains up to 50 per cent of securities lending revenues from one of its Tokyo-listed ETFs. Tony Hanlon, who regulates asset managers at the UK's Financial Services Authority, said last month that European investment banks that offer derivative-based ETFs return securities lending revenue to shareholders only "from time to time and at their own discretion." Additional reporting by Chris Flood