# Index is better than actively managed funds



## CuriousReader (Apr 3, 2009)

Whenever you meet financial planner and you talk about index they will come up with reasons and materials that back up their claim that the actively manage fund will do better.

Below is exactly the kind of materials they will present to you. Here, it clearly show how the fund (FID231) is doing much better than the index (S&P Capped 60).
This looks like a factual prove that actively manage funds do better. So how is index better?


imageupload


----------



## swoop_ds (Mar 2, 2010)

Often they take a basket of actively managed funds, find the one that 'happened' to have outperformed, and show you that one. For every one that outperforms, there are a bunch that don't. (and nevermind the fees you're paying).

The problem is finding which funds will outperform. Past performance doesn't garantee future performance.


----------



## cainvest (May 1, 2013)

It's also a good idea to look further back, how has the fund done since inception?


----------



## GoldStone (Mar 6, 2011)

Check out this fund's asset allocation
http://quote.morningstar.ca/quicktakes/fund/f_ca.aspx?t=F0CAN05TD1&region=can&culture=en-CA

Cash: 5.75%
Canadian equity: 49.88%
US equity: 30.25%
International equity: 14.12%

S&P/TSX 60 is a wrong benchmark for this fund because it invests so much outside of Canada.

According to the fund home page, the right benchmark is a blend of 70% S&P/TSX 60 Capped Index and 30% S&P 500 Index.


----------



## OptsyEagle (Nov 29, 2009)

Not to reignite this discussion, since I believe the flames of it are still burning on a couple of other threads, you should be aware that although it is mathematically impossible for the average active manager to beat his/her benchmark, it is also impossible for the index to beat all active managers, all the time.


----------



## andrewf (Mar 1, 2010)

Not necessarily, after fees. Just very unlikely.


----------



## humble_pie (Jun 7, 2009)

OptsyEagle said:


> Not to reignite this discussion ...



oh, but i think the discussion should stay live, although it would help everyone if it would tame down into a dialogue. A dialogue that should last several years, since there is so much to be uncovered & discovered.

already, in cmf forum, ETF industry spokespersons/salesmen have revealed that ETFs often don't hold the stocks they claim they hold, they hold sampled lists of stocks instead.

then the spokes/sales persons went on to discuss how ETFs are lending out some of the stocks they do own. To "hedge funds," although apparently it is the uniting broker that indemnifies the loan deal, so one has to assume that the actual stocks in question are lodged at said broker. For the simple reason that no institution would indemnify without collateral.

but the brokers, in turn, are mostly owned by the banks, so we're back to the banks again ...


----------



## GoldStone (Mar 6, 2011)

Mutual funds engage in security lending just like ETFs.

Fidelity fund mentioned in post #1 does it too. Their annual report says as much. It charges 2.3% MER for the privilege.

cainvest and I checked a few mutual funds the last time we had this "dialogue". A few bank-owned mutual funds that we looked at were *more aggressive* in their security lending practices than comparable ETFs.


----------



## GoldStone (Mar 6, 2011)

humble_pie said:


> already, in cmf forum, ETF industry spokespersons/salesmen have revealed that ETFs often don't hold the stocks they claim they hold, they hold sampled lists of stocks instead.


This criticism is funny, coming from the spokes/sales person for a grotesquely undiversified 5 pack.

The vast majority of ETFs use full index replication. A few ETFs that use sampling do it for a perfectly good reason: to reduce investors' costs.


----------



## cainvest (May 1, 2013)

GoldStone said:


> Mutual funds engage in security lending just like ETFs.
> 
> Fidelity fund mentioned in post #1 does it too. Their annual report says as much. It charges 2.3% MER for the privilege.
> 
> cainvest and I checked a few mutual funds the last time we had this "dialogue". A few bank-owned mutual funds that we looked at were *more aggressive* in their security lending practices than comparable ETFs.


Oh but it gets even better .... individual companies can also use derivatives, guess some negative ETF people are going to completely get out of equities now!


----------



## GoldStone (Mar 6, 2011)

cainvest said:


> Oh but it gets even better .... individual companies can also use derivatives, guess some negative ETF people are going to completely get out of equities now!


Good point. 

Anti-ETF-conspiracy spokesperson owns a few thousand shares in CPG and VRX. Each position is worth 6 digits. How hypocritical. Both companies use derivatives. VRX does it from time to time. CPG does it all the time.

======

Crescent Point Energy:

"Crescent Point actively hedges commodity prices, using a rolling 3-½ year price risk management program. We hedge up to 65 percent of after-Crown royalty volumes, using a portfolio of swaps, collars and put option instruments."

=====

Valeant Pharmaceuticals:

"From time to time, the Company utilizes derivative financial instruments to manage its exposure to market risks, including foreign currency and interest rate exposures."


----------



## andrewf (Mar 1, 2010)

Why do we want a rehash of this? HP will make a bunch of unsubstantiated claims about fraud and misrepresentation by ETF providers...


----------



## cainvest (May 1, 2013)

lol ... let's put the dead horse to rest on this, it's taken enough of a beating already.

Now back to the scheduled "active management fund" topic!


----------



## GoldStone (Mar 6, 2011)

andrewf said:


> Why do we want a rehash of this? HP will make a bunch of unsubstantiated claims about fraud and misrepresentation by ETF providers...


She already made a bunch of her usual unsubstantiated claims in post #7.

I have no desire rehash this discussion. But I also feel that unsubstantiated, made-up claims have to be challenged and refuted, for the benefit of the newbie onlookers.


----------



## humble_pie (Jun 7, 2009)

GoldStone said:


> This criticism is funny, coming from the spokes/sales person for a grotesquely undiversified 5 pack.
> 
> The vast majority of ETFs use full index replication. A few ETFs that use sampling do it for a perfectly good reason: to reduce investors' costs.



transparently, the ETF industry "sales" person on here is goldstone. The way he resorts to cheap cracks like the above is a giveaway each:

me, i'm not selling anything, i'm just a humble scribe, with the fondness for asking questions that all well-trained scribes have.

maybe learn to deal with it, goldstone? there may be only a few questioners now, but in due course the trickle could turn into a flood of investors all wanting to look under the hoods of the ETFs they've been told are fail-proof.

in addition, there is nothing "grotesque" whatsoever about a well-balanced 5-sector group of 5 top-quality companies for an emerging or young investor. Plenty of cmf forum members have long since unbundled their XRE holdings, picked out 2-3-4 individual REITS & gone on their merry way.

other investors have easily selected the better candidates out of the TSX top 60.

as Argonaut - who invented the 5-balanced-stock strategy - used to say, why own the losers that are present in every index?


----------



## My Own Advisor (Sep 24, 2012)

humble_pie said:


> Plenty of cmf forum members have long since unbundled their XRE holdings, picked out 2-3-4 individual REITS & gone on their merry way.


Count me in as one of those. 

Let's see, I can either own ZRE, XRE, or VRE and pay 0.40% MER or more, or just own these CDN REITs for a one-time fee, let them DRIP and be done with it:

RioCan REIT
H&R REIT
Canadian REIT
Dream Office REIT
Calloway REIT
Boardwalk REIT
Cominar REIT

Beyond that, add in a few CDN banks and telcos and pipelines and DRIP all those, and then index everything else if you choose. Portfolio done!


----------



## humble_pie (Jun 7, 2009)

andrewf said:


> Why do we want a rehash of this? HP will make a bunch of unsubstantiated claims about fraud and misrepresentation by ETF providers...



lol another well-known ETF industry shill speaks

the smell of a certain ETF house keeps on getting more & more odoriferous


----------



## humble_pie (Jun 7, 2009)

cainvest said:


> Oh but it gets even better .... individual companies can also use derivatives, guess some negative ETF people are going to completely get out of equities now!



there is a world of difference between options on organized options exchanges - the only kind of derivatives that i trade - & the hidden securities lending (some call it swapping) that goes on at funds.

options are publicly traded, guaranteed by the exchanges themselves. The host options exchange acts as the counterparty. The options trader never has to worry who an ultimate counterparty might be, because the exchange will always intervene.

the costs for this greater degree of security are fairly high, so most funds don't go the option route. Instead, they lend directly to counterparties. A broker marrying the deal may agree to indemnify the loan, but in the end all that this means is that the bank that owns the broker probably has a degree of liability ... although this would likely depend upon the loan agreement.

cainvest, based on what you have told us about your investment experience, do you not think that, when it comes to options & other derivatives, you are perhaps in somewhat over your head?


----------



## cainvest (May 1, 2013)

humble_pie said:


> there is a world of difference between options on organized options exchanges - the only kind of derivatives that i trade - & the hidden securities lending (some call it swapping) that goes on at funds.
> 
> options are publicly traded, guaranteed by the exchanges themselves. The host options exchange acts as the counterparty. The options trader never has to worry who an ultimate counterparty might be, because the exchange will always intervene.
> 
> ...


I see companies that use derivatives in the same light as MFs and ETFs ... no big deal as long as the exposure is very limited (as we've seen in ETFs) and shown on the financial reports.

Sure I'm in over my head sometimes but I learn and do my best to provide accurate information. Don't think many average investors know exactly what every line on a financial report is. But unlike some posters, I don't spread fear, uncertainty and doubt for no reason or continuously respond with derogatory comments when something is posted that I don't agree with.


----------



## GoldStone (Mar 6, 2011)

humble_pie said:


> there may be only a few questioners now, but in due course the trickle could turn into a flood of investors all wanting to look under the hoods of the ETFs they've been told are fail-proof.


Yes, yes, you uncovered a conspiracy. Kudos to you. It's only a matter of time before the rest of investment world catches up. 




humble_pie said:


> in addition, there is nothing "grotesque" whatsoever about a well-balanced 5-sector group of 5 top-quality companies for an emerging or young investor.


Pick 5 top-quality companies in 5 sectors? OMG, that's index sampling. Poorly diversified sampling, but sampling nevertheless.

I thought that sampling was part of the evil ETF conspiracy you uncovered? My head hurts. 




humble_pie said:


> Plenty of cmf forum members have long since unbundled their XRE holdings, picked out 2-3-4 individual REITS & gone on their merry way.


There you go, that's evil sampling again. 2-3-4 is an index sample. Call the press!!! 

Seriously though, XRE is a perfect candidate for unbundling. The MER is way too high for what it offers. 

See? I am more than willing to accept a valid criticism of an ETF. Such as high cost and poor diversification in the case of XRE.




humble_pie said:


> other investors have easily selected the better candidates out of the TSX top 60.
> 
> as Argonaut - who invented the 5-balanced-stock strategy - used to say, why own the losers that are present in every index?


It's good that you and Argonaut know how to separate the winners from the losers. Can I borrow your crystal ball? Mine is cloudy. 

I am not against 5-pack by the way. It's a reasonably sensible strategy. All the power to anyone who wants to follow it.

I am not against ETF unbundling either. I unbundled my Canadian ETF a few years back - as I mentioned many times in the forum.

What I am against is unsubstantiated anti-ETF falsehoods that you keep spreading from thread to thread.


----------



## gardner (Feb 13, 2014)

One thing I find interesting is that most indexes contain stocks with a dividend yield -- the TSX60 has a trailing yield of 2.3%. So when the managed fund "outperform" the index, are they just folding in the drips from the dividend yield?

I was digging around in Investors Group and I had a look at one of their funds MUTF_CA:IGI489 (Investors Canadian Equity Income) -- the shape of the price curve matches TSX:XIU dip-for-dip -- but the overall performance lags by a few percent per year over every timescale. It's hard to see how this fund is not exactly the TXS60, less the MER (2.6%) and dividends.


----------



## cainvest (May 1, 2013)

gardner said:


> I was digging around in Investors Group and I had a look at one of their funds MUTF_CA:IGI489 (Investors Canadian Equity Income) -- the shape of the price curve matches TSX:XIU dip-for-dip -- but the overall performance lags by a few percent per year over every timescale. It's hard to see how this fund is not exactly the TXS60, less the MER (2.6%) and dividends.


While the mentioned IG fund and XIU are somewhat related, their sector weights are a fair bit different. Also the IG fund states it targets 0 to 30% towards foreign securities but may go up to 50%. From what I see the IG fund has outperformed XIU every year since 2009 but of course you're not covering the same securities.


----------



## humble_pie (Jun 7, 2009)

GoldStone said:


> ... What I am against is unsubstantiated anti-ETF falsehoods that you keep spreading from thread to thread.



i vigorously deny that i have ever spread falsehoods in this forum, whether with respect to ETFs or any other issue. I am appalled at such an adolescent insult.

here is an example of an iShares US ETF T-bill fund, close sibling of the above-mentioned SHY & SHV, which i believe does not fairly & transparently represent itself, to a reasonably ethical degree that would be satisfactory to consumers, to investors who seek to look under its hood. Not even in its audited financial statements, whose screenshots are presented below.

this is iShares 3-7 year US T-Bill ETF, symbol IEI.

lending of IEI's securities is rampant. More than half the securities are loaned out. They are the securities marked with an (a) on the attached screenshot, an (a) that is so tiny & so faint that no one can read it. Dollarwise, these securities amount to nearly a third of the fund's assets.

these facts are summarily treated in minimal footnotes at the bottom of page 2 of the same audited financial statement (screenshot), in language that is so obtuse & so opaque that no ordinary investor can easily understand.

notice, too, what iShares has done with collateral received for the loan of the securities (screenshot, footnotes, page 2). IShares has used these funds to buy private in-house money market instruments, for which there could be a possible conflict of interest. Presumably from these private funds, iShares draws part of the pittance distributed to public unitholders that is supposed to mimic distribution from the index list of T-bills, then divides any surplus between itself & the public ETF.

haroldCrump has posted cases where shareholders have sued certain ETF vendors over failure to compensate the ETFs themselves with revenues from securities loan programs.

note to goldstone: you might have been pleased to notice that, according to HC, your fave vanguard was the sole ETF vendor that had actually returned loan revenues to the funds; black rock stood out for having kept loan revenues for itself. One observes that black rock has since learned to mend its ways, at least somewhat.

in addition, the audited iShares financial statement has this to say about all its US T-bill ETFs, including IEI, the 3-7 year ETF:

_The iShares 3-7 Year Treasury Bond ETF (the “Fund”) seeks to track the investment results of an index composed of U.S. Treasury bonds with remaining maturities between three and seven years, as represented by the Barclays U.S. 3-7 Year Treasury Bond Index (the “Index”). The Fund invests in a representative sample of securities included in the Index that collectively has an investment profile similar to the Index. Due to the use of representative sampling, the Fund may or may not hold all of the securities that are included in the Index._

lastly, i have never seen, in any ETF financial statement, any precise indication of which stocks are actually held in sampled lists vs which stocks are only being named because they are components of an index that is nominally being duplicated. Lists of stocks *held* according to audited financial statements do not show which stocks are actually held & which are missing.

in some cases, lists of stocks *held* as per audited financial statements are not held in reality, but only serve to indicate an index that is being tracked. In one such infamous case, the iShares India ETF, zero stocks are held. This ETF holds nothing but an index run out of the island of Mauritius in the indian ocean. Yet the audited financial statements piously show that the ETF *holds* a list of common shares of 51 of india's biggest companies.

IMHO these kinds of omissions & misrepresentations, even within audited financial statements, are borderline scandalous. They are also universal in the fund industry.

it is no wonder that consumers believe that their funds *are* holding exactly what the financial statements - such as this statement for iShares IEI - claim. No wonder even licensed financial professionals also believe these claims.

what i would like to see is reform in the reporting of these funds, so that consumers can clearly observe & easily understand that 1) fund *lists* of *holdings* may be samples only; & 2) some or many of the securities allegedly *held* by such ETF fund may, in reality, be held elsewhere because they have been loaned out.
.









.


----------



## lonewolf (Jun 12, 2012)

It is hard for a fund to out perform an index when near tops investors put money in the fund to invest & want to be long. Even though the fund manager might not want to invest near tops if he does not t he holders of the fund will take their money out. Near bottoms investors take their money out so the fund manger needs to sell to meet redemptions. Even if the fund manager is good money flow in & out of the fund goes against the fund manager


----------



## PuckiTwo (Oct 26, 2011)

lonewolf said:


> It is hard for a fund to out perform an index when near tops investors put money in the fund to invest & want to be long. Even though the fund manager might not want to invest near tops if he does not t he holders of the fund will take their money out. Near bottoms investors take their money out so the fund manger needs to sell to meet redemptions. Even if the fund manager is good money flow in & out of the fund goes against the fund manager


That is certainly an interesting view point. Thks! It really makes sense.


----------



## james4beach (Nov 15, 2012)

humble_pie is correct that many ETFs lend out securities. Mutual funds do it too.

At one point, TLT (a famous 'treasury bond ETF') had loaned out 40% of its assets! You think it's a treasury fund, but 40% was in commercial paper.

humble is also right to point out that many ETFs aim to "track" an index, which is not the same as saying they will buy the index precisely. What shortcuts are they taking? These are all valid points and are real risks of ETF and mutual fund investing.

We have to balance the argument though by pointing out that the alternative (holding individual stocks as opposed to funds) has some similar risks. Certainly, if you employ any margin at all, the broker has the right to lend out your shares. Countless brokers around the world have been caught lending away securities that should have been inside client accounts.

Furthermore, MF Global -- a giant American brokerage -- lost assets in client accounts that were supposed to be segregated. This shows that major brokerages don't necessarily obey "segregated" securities positions. Nobody at MF Global has been convicted of a crime, showing that brokers can lend your assets away with impunity.

Take-away message: yes, ETFs and mutual funds do lend away your assets. Brokers do it with individual stocks/bonds too, particularly in margin accounts. My sense is that the securities lending happens to a much higher degree with ETFs and mutual funds, so it probably is safer to hold individual stocks.


----------



## HaroldCrump (Jun 10, 2009)

There is no regulation on what % of securities are allowed to be leased out, the indemnification process, and the protection of registered accounts.
Due to the lack of a central regulatory body in Canada, this regulation falls in no man's land between the OSC, BoC, OSFI and the MoF.
Lenders of securities are not required to buy mandatory CDSs on the borrowers (which are problematic by themselves).

Any self-regulated standards around the type and quality of collateral are easily flouted by the borrowers by using swaps with other institutional lenders.
The institutions (hungry for yield) are happy to swap junk bonds for low yield treasuries, which are then used as collateral in a securities lending transaction.
There are layers upon layers of counterparty risks.
The risk in the system grows exponentially.


----------



## GoldStone (Mar 6, 2011)

Anti-ETF fear mongers refuse to acknowledge two simple points.

1. Most Vanguard ETFs use full index replication. Index sampling is a rare exception.
2. Vanguard ETFs lend securities very sparingly. They don't go for lending volume like BlackRock.

As to all other "bad ETFs"? You don't have to buy them. Just like you don't buy "bad stocks". Security lending is fully disclosed in the ETF annual reports. One can easily check the numbers before hitting Buy. It's a trivial check compared to proper due diligence on an individual stock.

How many couch potatoes own IEI? I am guessing zero. You won't find it in the recommended portfolios on the potato sites. IEI is a specialty ETF meant for the sophisticated investors who want to express a view on the shape and direction of the yield curve. These investors know how to read the fine print in the annual report.


----------



## humble_pie (Jun 7, 2009)

GoldStone said:


> ... Security lending is fully disclosed in the ETF annual reports. One can easily check the numbers before hitting Buy. It's a trivial check compared to proper due diligence on an individual stock.


 
this is absolutely untrue. Security lending is *not* properly disclosed in the annual financial statements. As i already mentioned - plus i posted screenshots to illustrate - it's only indicated in miniscule hieroglyphics, only referred to in brief, terse, incomprehensible notes.

no one can easily check the numbers. Far from being a trivial check, it is near-impossible for any investor to understand that *sampling* & *lending* mean that the list of stocks published as the *holdings* of an ETF in its annual financial statements is a fiction.

every investor i know believes that all stocks in such a list are 100% literally held in custody, exactly as stated, by the fundco. More alarmingly, every broker representative i've recently asked also believes this.

i for one think that the regulations are far too lax. I think that fundco lists of *holdings* in financial statements should state only the stocks that are in professional 3rd party custody. Stocks that are not part of an index that is being tracked, but are present only for sampling purposes, should be precisely identified. Stocks loaned out & being held at brokers for the benefit of what goldstone claims are "hedge funds" should appear in a secondary list.

consumers should be asking for more clarity, imho. Although regulatory authorities are becoming stricter, not easier, they cannot act unless the consumers communicate their needs for better information to them.


----------



## humble_pie (Jun 7, 2009)

james4beach said:


> ... We have to balance the argument though by pointing out that the alternative (holding individual stocks as opposed to funds) has some similar risks. Certainly, if you employ any margin at all, the broker has the right to lend out your shares. Countless brokers around the world have been caught lending away securities that should have been inside client accounts ...
> 
> Take-away message: yes, ETFs and mutual funds do lend away your assets. Brokers do it with individual stocks/bonds too, particularly in margin accounts. My sense is that the securities lending happens to a much higher degree with ETFs and mutual funds, so it probably is safer to hold individual stocks.



it's true there are risks everywhere. But let's move on in a practical direction.

IMHO there is better recourse for canadian clients of a canadian brokerage that is borrowing their stocks for margin usage, than for canadian holders of a foreign ETF, including US-based ETFs. 

although the regulatory framework in canada is a mishmash - we have no national securities commission as yet - nevertheless we do benefit from certain regulators whom we can easily contact. There are the IIROC, the OSC, the quebec AMF, the superintendent of financial institutions, the finance ombudsperson, etc.

by contrast, the canadian retail holders of a US based ETF have no recourse to the SEC of the United States. Nor do they have recourse to the regulatory authorities of any other country. The situation can be particularly unnerving with global ETFs since borrowing counterparties - in the lending schemes - might be hedge funds in johannesburg or singapore or melbourne australia. We as tiny canadian retail investors can have no clue whatsoever as to which indemnifying brokers could be holding a fund's borrowed shares, therefore we cannot know which banks own or back such brokers. 

bref, all this means no possibility of foreign recourse.

i've been looking into the regulation of ETFs for a couple of years now, ever since i noticed, with the debut of horizons' ultra-low-MER HXT, that a number of tricky proxy positions, even outright swaps, were being used in lieu of the plain common stocks that people still believe are present. (you know, the stocks that the financial statements tell us are being held ... except when they're not being held.)

i'm coming to the belief that a plain group of well-known stocks, held in outright ownership at a canadian broker, is indeed somewhat safer than any couch potato portfolio holding mostly non-canadian ETFs (keep in mind that most couch potato formulas will overweight US & international stocks & bonds, compared to canadian.)

the next task will be to discern how to get some overseas market exposure while still holding plain vanilla canadian & US stocks. Luckily both countries have long traditions of successful multinational operations, so for me these add overseas economies while still providing the familiar accounting practices & the familiar business conventions of home.


----------



## james4beach (Nov 15, 2012)

GoldStone said:


> Security lending is fully disclosed in the ETF annual reports.


This isn't true. I've been analyzing ETF financial statements for many years, and it took me a while to get good at hunting down securities lending. The Canadian iShares disclosure is actually one of the clearer better disclosures I've seen. I've also seen audited financial statements from more than one US ETF provider (Schwab comes to mind) with *no disclosure* of securities lending activity.

Securities lending is done in a very tricky way, and I think the audited financial statements mislead investors -- possibly causing them harm, in case of counter-party failure. Since when has it been legal for auditors to list "contents of the account" when some of those contents are not actually present in an account?



humble_pie said:


> i'm coming to the belief that a plain group of well-known stocks, held in outright ownership at a canadian broker, is indeed somewhat safer than any couch potato portfolio holding mostly non-canadian ETFs


I agree that on the dimension of security lending/counterparty risk, yes stocks held at a Canadian broker are likely safer than foreign ETFs. To make it safer, don't employ margin (as margin gives the broker the permission to lend out shares). To make it even safer, hold the shares in a cash settled, non-margin account.


----------



## GoldStone (Mar 6, 2011)

humble_pie said:


> Security lending is *not* properly disclosed in the annual financial statements. As i already mentioned - plus i posted screenshots to illustrate - it's only indicated in miniscule hieroglyphics, only referred to in brief, terse, incomprehensible notes.


This is spin. It shows your bias.

It took me less than a minute to find IEI annual report.

Google "IEI ETF".
Open IEI home page.
Click All Documents.
Select Annual Report.

Here it is.
http://www.ishares.com/us/literature/annual-report/ar-ishares-treasury-bond-etfs-02-28.pdf

Table of Contents says that IEI report starts on page 21.
Page 21 shows Schedule of Investments.
Loaned securities are clearly marked with (a). I can see it without my reading glasses.
Footnote (a) says: _"All or a portion of this security represents a security on loan. See Note 1"_. This is grade 5 level English. 

Next step: read Note 1.

Don't understand Note 1? Don't like what it says? Don't buy this ETF. As simple as that. You only need to do this exercise *once*. This is much easier than weeding out looser stocks.

Furthermore, IEI is a red herring. *You* chose it. IEI is a specialty ETF. Couch potatoes don't use it.

Once again, you refused to acknowledge two simple points:

1. The vast majority of Vanguard ETFs use full index replication.
2. Vanguard loans securities very sparingly. Vanguard lending revenue is puny compared to their enormous asset base.

Anyone can build a rock solid portfolio of 3-5 Vanguard ETFs without doing any due diligence on the inner ETF mechanics. Just copy the recommended portfolios on the reputable potato sites.




humble_pie said:


> Far from being a trivial check, it is near-impossible for any investor to understand that *sampling* & *lending* mean that the list of stocks published as the *holdings* of an ETF in its annual financial statements is a fiction.


This is spin again. The list of holdings is not a fiction.

1. I don't think you understand how index sampling works. A few rare ETFs that use index sampling list only those positions that they *actually own*. They don't list the index members that they chose not to buy. 

For example: An index includes 1000 positions. An ETF owns 900 of them. The annual report would show 900 positions that ETF owns. It would never show the other 100. If you think otherwise, you are mistaken.

2. ETF *owns* loaned holdings. Each loaned holding is secured by a collateral. We can debate collateral risk, but it's spin to say that loaned holdings are fiction. I own a bunch of stocks in my margin account. TDDI can loan them without my knowledge. Is my margin account statement a fiction? Is *your* margin statement a fiction? I don't think so.




humble_pie said:


> More alarmingly, every broker representative i've recently asked also believes this.


You work with broker representatives? Can you tell us where you work? Just curious...




humble_pie said:


> I think that fundco lists of *holdings* in financial statements should state only the stocks that are in professional 3rd party custody. Stocks that are not part of an index that is being tracked, but are present only for sampling purposes, should be precisely identified.


It is not necessary to identify them because they are not listed in the first place. You reach wrong conclusions when you start with bad assumptions.




humble_pie said:


> Stocks loaned out ... _<clip some obnoxious spin>_ ... should appear in a secondary list.


I can agree that loaned securities should be identified. As we saw, BlackRock is already doing this. I'm not sure what an average consumer would do with this information, though.


----------



## GoldStone (Mar 6, 2011)

james4beach said:


> Take-away message: yes, ETFs and mutual funds do lend away your assets. Brokers do it with individual stocks/bonds too, particularly in margin accounts. My sense is that the securities lending happens to a much higher degree with ETFs and mutual funds, so it probably is safer to hold individual stocks.


This is not a fair statement. You have to examine ETFs and mutual funds one by one. Some are active lenders. Many others are not. 

Furthermore, I can access the level of lending activity in my Vanguard ETFs (see below). I have no faintest idea how much lending TDDI does in my margin account.




james4beach said:


> This isn't true. I've been analyzing ETF financial statements for many years, and it took me a while to get good at hunting down securities lending. The Canadian iShares disclosure is actually one of the clearer better disclosures I've seen. I've also seen audited financial statements from more than one US ETF provider (Schwab comes to mind) with *no disclosure* of securities lending activity.


ETF providers typically disclose the total lending revenue in the ETF statement of operations. Please show me an ETF that doesn't disclose this line item.... I'm curious.

You can divide ETF lending revenue by ETF AUM to get the percentage number. You can use this number to gauge the level of lending activity. Compare the number to other ETFs. Don't like what you see? Find a better ETF. Shouldn't be too hard. Vanguard lending revenue is puny compared to assets.


----------



## humble_pie (Jun 7, 2009)

james4beach said:


> This isn't true. I've been analyzing ETF financial statements for many years, and it took me a while to get good at hunting down securities lending. The Canadian iShares disclosure is actually one of the clearer better disclosures I've seen. I've also seen audited financial statements from more than one US ETF provider (Schwab comes to mind) with *no disclosure* of securities lending activity.
> 
> Securities lending is done in a very tricky way, and I think the audited financial statements mislead investors -- possibly causing them harm, in case of counter-party failure. Since when has it been legal for auditors to list "contents of the account" when some of those contents are not actually present in an account?




this last sentence bothers me the most. I really cannot understand how the regulations can be so lax, that fundcos & their auditing accountants are allowed to present the lists of *holdings* in annual financial statements as if the funds actually held all of those very securities.

this seems dishonest. It seems borderline scandalous. At the very least it is deceiving consumers on a grand scale.

it's all made worse by the fact that the industry spokesmen - as we have seen in this thread - will try every trick in the book to prevent the topic from being discussed.

as i mentioned upthread, one of the worst cases is the ishares india ETF, which owns zero common stocks. Its prospectus makes abundantly clear that it owns zero common stocks. What it does own is an index run out of Mauritius, an island in the indian ocean. Yet somehow the regulations are OK with the fact that this fund can blatantly claim, in its audited financial statement, that it *holds* 51 of india's largest & finest stocks!

but if these things are going on - if stuff is happening like Schwab runs funds that loan out securities but Schwab fails to disclose this in any of their mandatory filings including their financial statements - then we can see that something is wrong with the very regulations themselves.

as i say, i've been puzzling over this for more than a year. About a year ago, i conducted an impromptu survey. I asked 3 big fundcos about the presence of samples, derivatives, swaps & other proxies in their "audited lists of holdings."

the answers i got back were troubling. Representatives at 2 calls centres assured me that lists of holdings were 100% accurate & complete as stated. Only horizons betaPro had represetatives at its call centre who could & did candidly discuss that HXT holds nothing but a bunch of swaps with National Bank.


----------



## james4beach (Nov 15, 2012)

GoldStone said:


> Furthermore, I can access the level of lending activity in my Vanguard ETFs (see below). I have no faintest idea how much lending TDDI does in my margin account.


This is a strong point, I acknkowledge your point here.



> ETF providers typically disclose the total lending revenue in the ETF statement of operations. Please show me an ETF that doesn't disclose this line item.... I'm curious.


That's their revenue from securities lending, but it doesn't tell you what % of their assets they are lending out. They may be lending it to an affiliated partner for peanuts; it doesn't give you a direct indication of how much of their assets they are lending out.

Here's one example: Schwab's bond ETFs (annual report PDF). Now the funny thing is that Schwab has great disclosure of securities lending in their equity ETFs, but not their bond ETFs.

The financial statements start on page 19 of the PDF. Jump down to page 26, "Schwab Short-Term U.S. Treasury ETF". It shows just a short, simple list of treasury bonds. If this was one of their equity funds, in this table you would see notes about which securities are out on loan (and how much). Continue to Investment Income (page 29) and you see income from "Securities on loan". *So they're either on loan at the time of this snapshot, or they're window dressing the books by pausing the lending at audit time -- a common accounting trick*.

Here's an example where there's definitely securities lending happening (Schwab Short-Term U.S. Treasury ETF and Intermediate-Term U.S. Treasury ETF) but there is no disclosure of the dollar amount out on loan. So you tell me: is there some place in this document where they tell me how much of the fund assets are loaned out?

As a unitholder, I'm concerned about risk. How much of MY ASSETS are exposed to counterparty risk, like a hedge fund blowing up while holding my bonds? What collateral have they received for the AAA treasury bonds they loaned out? (I'll bet they received crappy commercial paper in return for my pristine t-bonds). How do I assess that risk? *Where is it documented?* They've clearly loaned out some of my bonds.


----------



## humble_pie (Jun 7, 2009)

GoldStone said:


> This is spin. It shows your bias ...


goldstone u are the one who's spinning so fast you can't even see your own bias, let alone your own vile insults.

have you any idea the kind of harm you are inflicting on your industry?
do you think anyone would refer clients to someone like you?
do you think anyone would want to remain the client of a rigid, iron-fisted, irascible preacher?
perhaps you'd be more at home with al-Nusra in syria, though?


----------



## humble_pie (Jun 7, 2009)

TDDI flawlessly indicates its margin borrowing from clients' accounts. Maybe some clients don't know how to read their statements?


----------



## GoldStone (Mar 6, 2011)

james4beach said:


> Here's one example: Schwab's bond ETFs (annual report PDF). Now the funny thing is that Schwab has great disclosure of securities lending in their equity ETFs, but not their bond ETFs.
> 
> The financial statements start on page 19 of the PDF. Jump down to page 26, "Schwab Short-Term U.S. Treasury ETF". It shows just a short, simple list of treasury bonds. If this was one of their equity funds, in this table you would see notes about which securities are out on loan (and how much). Continue to Investment Income (page 29) and you see income from "Securities on loan". *So they're either on loan at the time of this snapshot, or they're window dressing the books by pausing the lending at audit time -- a common accounting trick*.


There is a flaw in your thinking. It's not an "either or" proposition.

They loan securities when there is demand. The demand is not always there***. Suppose they loan some securities to a short seller. After a month or two, the short seller covers the shorts and returns the securities. At the end of the year, the fund reports the total lending income earned throughout the year. They also report no positions on loan. The two parts of the report are fully consistent with each other. They don't need any accounting tricks.

*** Lack of demand is the main constraint that limits security lending by ETFs and mutual funds. Short-selling is a large market, but it pales in comparison to the long-term, buy & hold assets.


----------



## andrewf (Mar 1, 2010)

HP, goldstone is being remarkably polite. You seem to accuse people of being vile monsters whenever they criticize you, but you seemingly have no qualms about questioning the motivation and ethics of others. I mean, you are equating GS's fact-based defense of ETFs from your drive-by smear of the whole industry with cherry-picked examples with violent fundamentalist islamism. Are you capable of self-reflection?


----------



## GoldStone (Mar 6, 2011)

humble_pie said:


> have you any idea the kind of harm you are inflicting on your industry?


You are absolutely right. I fail to see the harm. After all, I am a software developer working for a high tech company. each:


OTOH, you didn't answer my question about your work relationship with the "broker representatives". You mentioned the relationship in post #29.


----------



## humble_pie (Jun 7, 2009)

GoldStone said:


> You are absolutely right. I fail to see the harm. After all, I am a software developer working for a high tech company



haha each: too late, that's been tried already


----------



## Ihatetaxes (May 5, 2010)

andrewf said:


> HP, goldstone is being remarkably polite. You seem to accuse people of being vile monsters whenever they criticize you, but you seemingly have no qualms about questioning the motivation and ethics of others. I mean, you are equating GS's fact-based defense of ETFs from your drive-by smear of the whole industry with cherry-picked examples with violent fundamentalist islamism. Are you capable of self-reflection?


+1

Thanks Andrew for expressing what I was thinking.

Goldstone I appreciate you continuing to provide good information and fact despite the fact you will never win an argument with HP.


----------



## RBull (Jan 20, 2013)

andrewf said:


> HP, goldstone is being remarkably polite. You seem to accuse people of being vile monsters whenever they criticize you, but you seemingly have no qualms about questioning the motivation and ethics of others. I mean, you are equating GS's fact-based defense of ETFs from your drive-by smear of the whole industry with cherry-picked examples with violent fundamentalist islamism. Are you capable of self-reflection?


This. Thanks also for posting. 

I was appreciating all of the discussion and information until the thread took a turn for the worse. Shame.


----------



## james4beach (Nov 15, 2012)

GoldStone said:


> There is a flaw in your thinking. It's not an "either or" proposition.
> 
> They loan securities when there is demand. The demand is not always there


OK, I see what you mean. They lend their assets if there is demand for their assets. So your interpretation of the financial statements I linked to is that there are no securities on loan at the time of this snapshot?

Still, I'd like to see better disclosure (industry wide) of these things. Unless the snapshot happens to catch the lending in action, you have no trace of what assets have been exposed to risk. Financial statements only offer 2 sampling instants through the year; there could be plenty of lending at all other times.


----------



## GoldStone (Mar 6, 2011)

james4beach said:


> OK, I see what you mean. They lend their assets if there is demand for their assets. So your interpretation of the financial statements I linked to is that there are no securities on loan at the time of this snapshot?


Yes.




james4beach said:


> Still, I'd like to see better disclosure (industry wide) of these things. Unless the snapshot happens to catch the lending in action, you have no trace of what assets have been exposed to risk.


Suppose they disclose the assets. What would you do with that info?




james4beach said:


> Financial statements only offer 2 sampling instants through the year; there could be plenty of lending at all other times.


Here's Schwab report that you linked in post #35.

http://hosted.rightprospectus.com/documents/Schwab/FIETF_ann.pdf

We are talking about "Schwab Short-Term U.S. Treasury ETF".

Page 28
Net Assets: $444,497,407

Page 29
Investment Income / Securities on loan: $340

The fund with *$444.5 million* in assets earned *$340* (three hundred forty dollars) from security lending.

According to Schwab: "Total costs and expenses, including agent fees and broker rebates, associated with securities lending activities accounted for about 15% of gross lending revenues in 2013".

$340 + 15% = *$391* gross revenue from securities lending

Are you seriously worried about that? Why?


----------



## GoldStone (Mar 6, 2011)

Andrewf, Ihatetaxes, RBull: thanks!


----------



## james4beach (Nov 15, 2012)

> Suppose they disclose the assets. What would you do with that info?


I would evaluate whether I'm comfortable with the amount of my assets that the fund administrator is lending away. He's exposing my assets to risks and I want to decide whether I'm going to entrust my assets to him.



> The fund with *$444.5 million* in assets earned *$340* (three hundred forty dollars) from security lending.


Yeah, it's a pittance and I'm glad to see they aren't lending much out from SCHO -- I hold that fund.

I linked to that report because I had it handy, as I had been analyzing it due to my recent purchase. It's just an example showing that sometimes all you are told is the 'lending revenue'... again my point remains, just knowing the revenue doesn't tell you how much of the assets they're lending out.

It's not acceptable for the fund industry to expose other peoples assets to risk with such poor disclosure. Mutual funds have been doing this for so long that they all consider it totally normal.


----------



## cainvest (May 1, 2013)

james4beach said:


> I would evaluate whether I'm comfortable with the amount of my assets that the fund administrator is lending away. He's exposing my assets to risks and I want to decide whether I'm going to entrust my assets to him.
> 
> Yeah, it's a pittance and I'm glad to see they aren't lending much out from SCHO -- I hold that fund.
> 
> ...


As you mentioned mutual funds have been doing this for a long time and with what, about a trillion dollars invested, there appears to be no news (reported anyways) on a default that has costed people money. Furthermore, after looking at a small sample, it appears mutual funds loan more securities than equivalent ETFs but who knows if this will change over time as ETFs are the new kids on the block. It's always wise to check each fund before you invest, especially so if they are a core holding in your portfolio.

No doubt it would be nice to always see (and without digging for the info) what's going on behind the scenes when additional risk is involved despite these loans having large amounts of collateral. iShares XIU and XIC appear to be lending 3.3% and 7.2% of their assets respectively, so it appears the exposure is not to large but you have to make your own call on that.


----------



## Eclectic12 (Oct 20, 2010)

^^^^

Unless the losses from lending out securities are huge ... I doubt we'd hear about it. 
It would be buried in the financial numbers, where overall it would just look like some bad decisions were made.


Cheers


----------



## cainvest (May 1, 2013)

Eclectic12 said:


> ^^^^
> 
> Unless the losses from lending out securities are huge ... I doubt we'd hear about it.
> It would be buried in the financial numbers, where overall it would just look like some bad decisions were made.
> ...


Don't think it would be buried, that would just show up as a huge loss under "Securities lending income" I would gather.


----------



## HaroldCrump (Jun 10, 2009)

cainvest said:


> there appears to be no news (reported anyways) on a default that has costed people money.


cainvest, there never is any news until the first domino falls.
Remember 2007? Or was it that long ago?
Until the first home builder filed for bankruptcy in the spring of 2007 (I believe it was Homestars), no one "saw" any "news" about "defaults that costed people money", yeah?
Until Countrywide filed for bankruptcy protection that same summer, no one "saw" any "news" about "defaults that costed people money".



cainvest said:


> Don't think it would be buried, that would just show up as a huge loss under "Securities lending income" I would gather.


Not at all.
Why should it show up as a loss under securities lending income?
The income is reported as and when it is accured.

In the event of a counterparty failure, one of two things can happen:

- The collateral turns out to be good, and the fund is able to redeem it to re-buy leased securities.
If they re-bought at higher prices, that'd be a loss for the fund (but not reported under securities lending income).
Conversely, if they re-bought at lower prices, that'd be a profit for the fund (albeit a short-lived one, since the securities at that point are probably headed downwards anyway).

- The collateral cannot be sold (either at mark-to-market, or not at all) and the fund needs to invoke the indemnification clause, and plead its case with the intermediatary and/or the regulators.
This situation has not happened yet (since 2008/9).

Above, GoldStone posted numbers that some fund made $340 from securities lending.
Are the proceeds worth the risk?
The cost of the paperwork required for securities lending is a lot more than $340 -- many X times more.
So, why bother?

The root cause of all this is the distortion of the financial markets caused by ZIRP and suppression of the yield curve.
The funds are so hungry for yields that they are blatantly ignoring the risks.
They are willing to do _whatever it takes_ (to borrow Dragi's words) to eke out the tiniest bit of yield that can be re-distributed to investors, either as cash payouts or in the form of reduced MERs.
If the yield curve were not suppressed by QE & LSAPs, the bond funds would have been able to generate enough distributable income from the treasuries and high grade corporate bonds to negate the need for all these shell games and shenianighans.

Anyway, my point is that just because something hasn't happened yet (or, rather, hasn't happened in the most recent memory) does not mean we can waive off the risk.
The property damage right before a T5 tornado hits the trailer park is precisely $0.
After the T5 has passed through, not so much.


----------



## cainvest (May 1, 2013)

HaroldCrump said:


> cainvest, there never is any news until the first domino falls.
> Remember 2007? Or was it that long ago?
> Until the first home builder filed for bankruptcy in the spring of 2007 (I believe it was Homestars), no one "saw" any "news" about "defaults that costed people money", yeah?
> Until Countrywide filed for bankruptcy protection that same summer, no one "saw" any "news" about "defaults that costed people money".


Well this lending has been going on much farther back than 2007 through a number of corrections and nobody has written about it (to my knowledge) or identified it as a real risk potential that should be heavily considered before investing ... kind of odd don't you think? Now I'm not saying there isn't risk here, of course there is but if the lending deals with small percentages and covered by collateral, aren't you making a mountain out of a molehill here?



HaroldCrump said:


> Not at all.
> Why should it show up as a loss under securities lending income?
> The income is reported as and when it is accured.


I gather it would show up there as that's where one would report a loss on securities lending, seems obvious to me but I'm not an accountant. 



HaroldCrump said:


> Above, GoldStone posted numbers that some fund made $340 from securities lending.
> Are the proceeds worth the risk?
> The cost of the paperwork required for securities lending is a lot more than $340 -- many X times more.
> So, why bother?


Small risk = small return ... couldn't guess why they did the loan, you'd have to ask them.



HaroldCrump said:


> The root cause of all this is the distortion of the financial markets caused by ZIRP and suppression of the yield curve.
> The funds are so hungry for yields that they are blatantly ignoring the risks.
> They are willing to do _whatever it takes_ (to borrow Dragi's words) to eke out the tiniest bit of yield that can be re-distributed to investors, either as cash payouts or in the form of reduced MERs.
> If the yield curve were not suppressed by QE & LSAPs, the bond funds would have been able to generate enough distributable income from the treasuries and high grade corporate bonds to negate the need for all these shell games and shenianighans.
> ...


Of course they're finding ways to make more money, that's really one of their goals isn't it?

And it's always about risk management, how many people live under ground in bunkers and never go outside due to the off chance an F5 tornado is going to hit ... ya, %0.000001 maybe? That's because they understand the risk is small, again, mountain out of a molehill situation.


----------



## HaroldCrump (Jun 10, 2009)

cainvest said:


> Well this lending has been going on much farther back than 2007 through a number of corrections and nobody has written about it (to my knowledge) or identified it as a real risk


The risk has indeed materialized a couple of times.
The LTCM bailout was one, but more recent was 2008/9.
The entire pyramid of leased, re-leased, and rehypothecated securities would have collapsed but for the bailout of Merill Lynch, AIG, and Bear Stearns.
Lots of people have written about it and explained the risk.



> Small risk = small return ... couldn't guess why they did the loan, you'd have to ask them.


It's the other way around.
Small return does not = small risk.


----------



## cainvest (May 1, 2013)

HaroldCrump said:


> The risk has indeed materialized a couple of times.
> The LTCM bailout was one, but more recent was 2008/9.
> The entire pyramid of leased, re-leased, and rehypothecated securities would have collapsed but for the bailout of Merill Lynch, AIG, and Bear Stearns.
> Lots of people have written about it and explained the risk.


I know about LTCM, watched a very good documentary on what happened with them.

And given that example, how did it affect the average MF, ETF invertor?

Point being, one that GoldStone made long ago on this topic, are you going to worry about the 3% on loan (with collateral) or the value of the 97% equity position you're holding?


----------



## humble_pie (Jun 7, 2009)

`

for me the issue is not whether the ETFs are sampling, or lending securities, or both.

IMHO the ETF vendors can lend or sample as much as they like. I don't care if they triple-leverage 100% of an ETF portfolio with loans to fly-by-night hedge funds operating out of guano-strewn tax haven Nauru, brokered by some financial house situated in singapore.

for me, the only issue that matters is that all such activities are being profoundly concealed.

the information is not presented until the nether pages of a website, in obscurely-worded footnotes to financial statements, or as notational systems that look like hieroglyphics, or both.

but where is the consumer/investor who reads those documents? why are ETFs that baldly state they hold zero shares, in fact they say they are holding nothing but a representational derivative product, nevertheless such ETFs are allowed to state in audited financial statements that they are *holding* in outright ownership, every single common share that constitutes a particular index which they are attempting to mimic? 

upthread i presented an iShares example of this kind of situation. It sure does look fishy to me.

so far, on these threads discussing ETF accounting procedures, only james4, haroldCrump, goldstone & myself have volunteered that we bother to read prospectuses & financial statements in full.

anyone else reading em on here? show of hands? is your ETF behaving like XIC? that is, is it presenting a full list of 251 TSX composite stocks as its actual *holding,* with no upfront, transparent disclosure of sampling, lending or any other impairment? is all this critical info relegated to the back pages, where it appears only as obscure footnotes & hieroglyphics?


----------



## christinad (Apr 30, 2013)

Curious reader,

You may want to read about the spiva report card

http://retirehappy.ca/spiva-scorecard/

It shows the percentage of funds that beat the index at 1, 3 and 5 years. It is too bad it doesn't show longer. It looks like your best bet for an actively managed fund is a canadian fund. I personally invest in mawer canadian equity but we'll see if it maintains its lead in 20 years. I say this because i think i read somewhere an actively managed fund would have to beat the index 40 years for it not to be chance. Maybe someone else remembers where this is from.


----------



## james4beach (Nov 15, 2012)

Yes mutual funds have been doing this for a long time. No, that doesn't make it OK. There were in fact securities lending related losses in the 2007/2008 crisis. Lehman Brothers was an active borrower in securities lending from mutual funds/ETFs, and they defaulted on those loans. The borrowers had to then liquidate the collateral -- during illiquid, distressed markets I may add -- and repurchase the securities that Lehman took to its grave.

Common sense tells you that they must have experienced losses. Sitting in that market turmoil of 2008, you can't possibly liquidate corporate paper without experiencing some losses.



cainvest said:


> Don't think it would be buried, that would just show up as a huge loss under "Securities lending income" I would gather.


No, it's more subtle. They won't be big, obvious losses in the financial statements. Losses can occur due to failure to return the assets in a timely manner, or failure by a borrower to pay mark-to-market differences. You can also experience depressed prices due to illiquid assets and collateral. Or the collateral they give you can be bad, like Fannie Mae paper (frequently this was the case leading up to 2007).

It all adds up to under-performance. You'll never be able to distinguish these kinds of drags from other inefficiencies (or volatile markets)... it will just be another one of those ways that banksters skim and suck value out of investments. They (the mutual fund) went and loaned your assets, behind your back -- as banksters invariably do. Now they have poor quality collateral to liquidate, and they scramble to repurchase your assets so you never knew. The result: poor performance, and yet again they've stolen some of your money with their shenanigans.


----------



## cainvest (May 1, 2013)

james4beach said:


> Yes mutual funds have been doing this for a long time. No, that doesn't make it OK. There were in fact securities lending related losses in the 2007/2008 crisis. Lehman Brothers was an active borrower in securities lending from mutual funds/ETFs, and they defaulted on those loans. The borrowers had to then liquidate the collateral -- during illiquid, distressed markets I may add -- and repurchase the securities that Lehman took to its grave.
> 
> Common sense tells you that they must have experienced losses. Sitting in that market turmoil of 2008, you can't possibly liquidate corporate paper without experiencing some losses.


I think everyone agrees that there are risks associated with lending, all funds that loan securities state that. Yes they have collateral and, at least some (all?), have a borrower default indemnity backing up the collateral if that should fail. BTW, indemnification for borrower default has come under scrutiny by regulators but I'm not sure if any changes have actually been made. 

In the end, if you are concerned about lending seek out different funds that either don't lend or only loan out a very small percentage (which seems to be the norm for some of the more common ETFs) that you can live with. And again, the pullback in 2008/2009 where equities dropped significant value greatly overshadows a "potential" loan default on a small percentage out on loan don't you think?


----------



## Pluto (Sep 12, 2013)

http://finance.yahoo.com/news/tony-robbins-says-mutual-funds-220000446.html

a mutual funds advertised returns are like online dating photos. lol


----------



## GoldStone (Mar 6, 2011)

*Security lending is a very serious risk in the bond funds* that hold all or significant portion of their assets in AA+ government bonds, such as US treasuries or Government of Canada bonds.

The reason is two-fold:

1. The quality of the money-market collateral cannot match the quality of the loaned government bonds.

2. In a T5 tornado scenario (using Harold's terms), high-grade government bonds are expected to go UP. The money-market collateral is expected to stay flat. In the worst case scenario, it may actually go down. The dropped collateral value may be insufficient to repurchase the government bonds.

The owners of the bond funds *must* scrutinize the lending activities with a big magnifying glass. I wouldn't want to own a government bond fund that loans more than a token amount of securities. Say, 3%-5% of assets at most.


*The above reasoning does not apply to the equity funds.*

1. A high-quality money-market collateral is far less risky than equities. They are at the opposite ends of the risk scale.

2. In a T5 tornado scenario, stocks would drop 50% or worse. A high-quality MMF collateral may lose some of its value, but not 50%-plus like equities. It's hard to imagine a scenario where a high-quality MMF collateral is insufficient to repurchase decimated equities. That's not a T5 tornado scenario. That's the end-of-the-world scenario.


----------



## HaroldCrump (Jun 10, 2009)

james4beach said:


> Common sense tells you that they must have experienced losses. Sitting in that market turmoil of 2008, you can't possibly liquidate corporate paper without experiencing some losses.


Of course there were issues with that.
However, all of that was covered up by TARP.

The Federal Reserve bought back all the toxic commercial paper from the banks and investments banks on to its own books (i.e. tax-payers' book) at par value, and re-issued gold plated treasuries in exchange (which it bought from the Treasury via Q/E-I).
The investment banks converted to retail banks on paper in order to make themselves eligible for this program.
Given that Glass-Steagal had already been repealed 15 years ago, it doesn't make any different anyway.

The vast majority of Americans did not understand exactly what happened, and how TARP/QE-I worked.
All they know is that the banks got "bailed out", similar to say GM or Chrystler.


----------



## GoldStone (Mar 6, 2011)

james4beach said:


> There were in fact securities lending related losses in the 2007/2008 crisis. Lehman Brothers was an active borrower in securities lending from mutual funds/ETFs, and they defaulted on those loans. The borrowers had to then liquidate the collateral -- *during illiquid, distressed markets I may add* -- and repurchase the securities that Lehman took to its grave.


To present a fair, balanced view, you should mention this wrinkle: the lenders repurchased the securities at a fraction of the loan value. Because the stock market dropped 50%.


----------



## james4beach (Nov 15, 2012)

GoldStone said:


> To present a fair, balanced view, you should mention this wrinkle: the lenders repurchased the securities at a fraction of the loan value. Because the stock market dropped 50%.


Unless the securities on loan were BONDS (such as treasury bonds) in which case the collateral declined in value and the bonds went up in value, meaning a notable loss in re-purchasing.


----------



## james4beach (Nov 15, 2012)

HaroldCrump said:


> Of course there were issues with that.
> However, all of that was covered up by TARP.


That's a great oversimplification, and inaccurate. Certain things were bailed out by the government, others were not. Commercial paper of Lehman Brothers went to zero. More importantly, other commercial paper -- even ones ultimately bailed out by government -- experienced significant declines in value before it bounced back. That results in real losses when the paper is liquidated as funds use the collateral to reacquire securities that they lost.


----------



## HaroldCrump (Jun 10, 2009)

james4beach said:


> Commercial paper of Lehman Brothers went to zero.


Not everything related to Lehman went to zero.
But regardless, as I have said before, Lehman was _allowed_ to go bankrupt, while other firms in similar situations were bailed out - Bear Stearns, Merill Lynch, and several banks.



> More importantly, other commercial paper -- even ones ultimately bailed out by government -- experienced significant declines in value before it bounced back.


Much of that was transferred to the balance sheet of the Fed at par value, not at discounted values.
In many cases, there was no way to mark those to market because there were simply no bids at any price.

_*In cases where it was possible to value the commercial paper, the Fed over-priced the toxic assets and took them on its books.*_

The Fed allowed the investment banks to swap that commercial paper at par value in exchange for liquid treasuries.

Are you refuting the evidence?

Note that I am not saying that the toxic commercial paper was good - I am saying that it didn't matter whether it was good or not, the Fed took it on par value.



> That results in real losses when the paper is liquidated as funds use the collateral to reacquire securities that they lost.


Most of those swapped securities have not been sold back to the market.
I already said above (or maybe it was on another thread about securities lending) that such a bailout is unlikely to occur again.
The Fed balance sheet is already $4T.
They cannot engineer another $3T of bailout in a second crisis even half the size of 2008.

Don't misconstrue my statements to mean that commercial paper as collateral is as good as Treasuries because they did not drop in value during 2008.
I am saying the opposite.

Also, how is it inaccurate to say that the underlying insolvency of the investment banks was not covered up by TARP and the Fed bailouts?
If TARP (and other related programs, including Q/E-I) had not been undertaken, several of the investment banks would have failed in addition to Lehman.
Note that both Bear Stearns and Merril Lynch came within 48 hrs. of Lehman-like collapse.
AIG was technically bankrupt on the same weekend that Lehman failed, but it was bailed out within 2 weeks of the Lehman failure.

Of course, TARP and related programs (like EESA) covered up the toxic commercial paper market in 2008/9.


----------

