# Securities lending amounts in ETFs



## james4beach (Nov 15, 2012)

Since I had the data on my screen anyway, I thought I'd share. These are just a few iShares ETFs I'm looking at, and is not an exhaustive list. But I link to the source documents so you can look up your own holdings.

Securities lending is a process in which the ETF provider lends out YOUR assets to other banks and hedge funds, incurring counterparty risk. The counterparty provides collateral to mitigate this risk. However, the collateral is not the same as the security. For example you probably want to hold a government bond because it will respond well during a crisis, and the cash/money market collateral you're holding instead is just not as valuable. The consequence is under-performance. There is also the risk that the collateral vaporizes. For example, during 2007-2008 many borrowers were providing Fannie Mae paper as collateral.

I would particularly be concerned with the securities lending occurring in bond funds, because the whole idea of holding bonds is to be insulated from market turmoil (which is the kind of thing that causes securities lending to blow up). For this reason, I only hold bonds individually and not through bond ETFs.

Notice that the heaviest securities lending is occurring in funds with the highest quality fixed income asset: government bonds. The reason is obvious when you think of it. Good quality assets are in high demand; everyone wants government bonds. When you hold CLF you think you're holding government bonds, but really you're only holding 70% government bonds. The rest are loaned out, because everyone wants good solid government bonds 

What % of the ETF is loaned out in securities lending? (See Note 10 in the iShares annual reports)

Bond ETFs (source: iShares annual report fixed income)

CLF 30%
XSB 21%
XGB 17%
XBB 13%

To me, all of these are worryingly high.

Stock ETFs (source: iShares annual report equities)

XCS 30%
XIN 20%
XSP 8%
XIC 6%
XIU 3%


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## james4beach (Nov 15, 2012)

Re-iterating, I hold government bonds individually. Why? Because if I hold one of the bond ETFs, I'm not really holding the government bonds -- they're out on loan.

Look at those iShares figures. They're lending out a ton of the ETF. The levels in XBB, XGB, XSB, CLF are all disgustingly high.

Here's the way this can blow up. Let's say you hold XSB, which is generally believed (even by myself) to be a very safe short-term bond fund. They've loaned out 21% of their fund, let's say these are all the best, most liquid t-bills and government bonds.

In return they receive money market collateral. _What exactly have they received_? Let me know if you find out. But it's probably a mix of commercial paper. Maybe it's some GE paper, some CIBC paper, some Citigroup paper and some alphabet soup ABCP.

And now the European crisis hits. Credit markets start falling apart, paper starts blowing up. GE becomes insolvent again and the paper plummets in value. Let's say a banking crisis starts and CIBC and Citigroup paper dips in value. The derivative soup ABCP blows up and becomes worthless, in credit crisis Round 2.

So what happens to our dear old XSB, the bastion of safety? Well the MM collateral they received is dropping in value... perhaps in a non-recoverable way. Let's say there's a 50% loss incurred on that 21% they loaned out. XSB loses 10% of its value.

But it's even worse than that. Because the damned assets they were supposed to be holding, those federal t-bills, actually soared in value, but you are no longer holding those assets. XSB was up nearly 8% in 2008. So let's say those best quality assets, the ones you no longer have (thanks to Blackrock's recklessness) actually went up 8%.

In this hypothetical scenario, as a consequence of securities lending, XSB underperforms by 18% -- a sum of the losses from securities lending collateral blowing up, plus the lost performance from the asset they failed to hold on your behalf.

And everyone sues Blackrock, and humble_pie says "told you so"


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## humble_pie (Jun 7, 2009)

james4beach said:


> Re-iterating, I hold government bonds individually. Why? Because if I hold one of the bond ETFs, I'm not really holding the government bonds -- they're out on loan.
> 
> Look at those iShares figures. They're lending out a ton of the ETF. The levels in XBB, XGB, XSB, CLF are all disgustingly high.



i'm surprised you've noticed. Yes, the bond lending levels are high. Not for the ultra-near-term 3-month T-bills, but once you look past a couple of years bond maturity, they are lending those mothers out like no tomorrow.

here's my thought. The ETF industry is mostly former mutual fund types who saw the fee writing on the wall 2 decades ago & took up the newly invented preaching called indexation. Amazingly, they have been able to brainwash an entire generation of investors into believing that the products are fail-proof, guaranteed.

the industry will not tolerate a few upstarts like haroldCrump & myself saying Heh, so there's not much point wasting one's energy. I only spoke out in stayThirsty's thread because a) i believe he'll make a good self-directed investor for a large part of his fortune some day; & b) his portfolio is large enough that optimal diversification can easily be achieved through the simple holding of common stocks.

it's late now ... gotta sign out ... some day i'll tell you the story about sitting in the cubicle of my favourite bank branch representative a couple months ago. Suddenly he began telling me how the mutual funds & the ETFs don't hold what they say they are holding.

very surprised, i asked him how he knew.

he said his best friend from college days is now a CFA working in the bank's investment banking division. It was the friend who clued him in. "They're all holding derivatives," the friend reportedly said.

i guess when they start talking like that in the hallowed halls of the big 5 chartered banks, the story is closer to the surface than i thought.

however, i still believe haroldCrump is right. It will take the meltdown of a big global money centre bank to expose the tiers of derivative products in every division, harold said.

have you heard, by the way, about CoCo bonds?


.


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## james4beach (Nov 15, 2012)

Good night humble and I can't wait to hear more -- please post more when you get a chance. I'd like to hear what your banking friend said. Some of these iShares ETFs are very full of derivatives. XIN comes to mind, with its myriads of FX derivatives (and tons of securities lending, it turns out). What a mess that XIN is.

I haven't heard of CoCo bonds. By the way, you may be aware that some of the American ETFs don't contain *any* assets at all. Some of them are exchange traded notes, and are nothing more than unsecured debt notes. No assets. Examples are DJP and XIV.

I'm very old fashioned. I like my government bonds, and I watch for signs that the broker actually holds the security and isn't doing sleight of hand. Does it show up as segregated in my monthly statements? Do I receive the coupon payments on time? I recently phoned TDDI and complained when my federal coupon came in a day late. Why the delay, I asked. Do I have the bond or not? And if I have it, what possible reason would there be for not receiving the coupon payment yesterday? Did the Government of Canada not make their payment on time? Of course they paid on time ... why didn't TDDI show the cash in my account? I have my suspicions, even with the best brokerages.


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## olivaw (Nov 21, 2010)

humble_pie said:


> the industry will not tolerate a few upstarts like haroldCrump & myself saying Heh, so there's not much point wasting one's energy. I only spoke out in stayThirsty's thread because a) i believe he'll make a good self-directed investor for a large part of his fortune some day; & b) his portfolio is large enough that optimal diversification can easily be achieved through the simple holding of common stocks.


Humble, James and Harold, please expend your energy to say Heh. I'd be interested in hearing about this. I'm OK if my broker or ETF managers lend the equities for interest - it helps keep my costs down. I'm less OK if they are holding derivatives that I cannot understand. Where does one look this up? 

Is money market collateral just cash that has been deposited into money market funds or is it something more exotic?


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## james4beach (Nov 15, 2012)

olivaw, the last time I got inside information on this (back in 2007), the securities lending collateral in the USA was commercial paper. Back then the typical collateral was a mix of 0-24 month bonds from issuers like: Goldman Sachs, Citi, Wachovia, GE, GMAC, Fannie Mae, Freddie Mac, Royal Bank, etc.

I don't know what they use today as collateral. It's not disclosed in the financial statements, which is why I'm highly suspicious. For example, how much Deutsche Bank commercial paper is used for this? That bank could blow up any moment.


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## humble_pie (Jun 7, 2009)

olivaw said:


> 'm OK if my broker or ETF managers lend the equities for interest - it helps keep my costs down. I'm less OK if they are holding derivatives that I cannot understand.




we are not really OK with the lending of fund securities though. Of the 2 risks - lending securities out & holding derivatives via sampling modalities - imho the lending is riskier by far. 

this is because the borrowing counterparties are unsecured. There is no intervening agency or entity that backs up anything. If the counterparty goes under, the entire loan goes under & the securities are forfeited.

stocks or bonds loaned out by an ETF in return for fees paid are mostly loaned to hedge funds. They sit at the broker who has married the lender to the borrower. This broker provides no guarantees. 100% of the loan risk depends upon the single counterparty.

to be sure, there is usually some boilerplate to the effect that the broker indemnifies itself, but all this means is that, in the event of counterparty failure, the broker will try to make whole if it can. In a global financial collapse, boilerplate like that means diddly.

multiply this scenario by a global financial collapse & one can see how alleged fund "holdings" can be lost in an hour.

it's the direct counterparty risk that is so dangerous, as james4 indicates when he names ETNs with their unbacked futures as high risk, just upthread.

by contrast, take stocks or options traded on senior public exchanges. The exchanges themselves guarantee payment or delivery (which is why they continuously monitor their member firms' aggregate positions) (which is why each broker, in turn, continuously monitors its individual client positions)

but a counterparty borrowing pledge has no backer, is meaningless.

to put things in broad general terms:

- in the event of a global financial collapse, at least some companies out of a suite of individual stocks held by an individual investor would likely survive;

- however, if all of the stocks were held in an ETF whose loaned securities were being held at a failed broker or subsidiary of a failing bank, the entire ETF could be at risk, depending upon the margin position of the fund.


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## james4beach (Nov 15, 2012)

humble_pie said:


> it's the direct counterparty risk that is so dangerous, as james4 indicates when he names ETNs with their unbacked futures as high risk, just upthread.


It's actually even worse as those ETNs I mentioned don't have any futures positions. They have no securities positions at all, it's quite incredible that this is legal.

I share humble_pie's views on this overall, by the way.


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## Video_Frank (Aug 2, 2013)

james4beach said:


> Bond ETFs (source: iShares annual report fixed income)
> 
> CLF 30%
> XSB 21%
> ...




From page 235 of your linked report:



> The Funds may lend their investment securities, through an agent, to approved borrowers such as brokers, dealers and other financial institutions. The Funds require collateral, currently in the form of obligations of, or guaranteed by, the Government of Canada or a province thereof or the United States Government or its agencies or instrumentalities or other high quality sovereign debt


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## olivaw (Nov 21, 2010)

Interesting discussion.

Can anybody answer the following? 

Are we talking about bond ETFs or stock ETFs too? 

Am I less protected when my ETF manager lends equities than when my brokerage (TDDI) is the lender? (It is my understanding the CIPF protects my account up to $1M if TDW fails but I have never investigated ETF insurance)


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## mordko (Jan 23, 2016)

Here is a neat little paper by Vanguard which explains the risks of security lending: https://personal.vanguard.com/pdf/icrsl.pdf

And in this leaflet they explain the scope of their lending. It's small-scale and secured by cash with clients getting the benefits. https://advisors.vanguard.com/iwe/pdf/Sec_lending.pdf

When one looks at how much funds like VTI are lending, it's a lot less than 1% of the fund market cap.


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## Market Lost (Jul 27, 2016)

When did GE ever become insolvent? Are you thinking GM?


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## Market Lost (Jul 27, 2016)

humble_pie said:


> i'm surprised you've noticed. Yes, the bond lending levels are high. Not for the ultra-near-term 3-month T-bills, but once you look past a couple of years bond maturity, they are lending those mothers out like no tomorrow.
> 
> here's my thought. The ETF industry is mostly former mutual fund types who saw the fee writing on the wall 2 decades ago & took up the newly invented preaching called indexation. Amazingly, they have been able to brainwash an entire generation of investors into believing that the products are fail-proof, guaranteed.
> 
> ...


Coco bonds are also known as "death spiral financing", or are at least they are if not done correctly. 

I'm not sure what your bank rep is getting at in reference to ETFs and derivatives. There are many ETFs that do use derivatives, some are completely synthetic such as Horizon's HXT and HSX, but this is clearly indicated in their documentation. Is he suggesting that people are being lied to, or is he merely suggesting that people aren't paying attention?


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## Market Lost (Jul 27, 2016)

olivaw said:


> Interesting discussion.
> 
> Can anybody answer the following?
> 
> ...


Equities are definitely loaned out; Blackrock even publishes a PDF about it. My problem with it isn't so much the risk, as it is actually very low. My issue is that the securities are often loaned to short sellers. Still, it's part of the price discovery, and it is supposed to keep management fees low, so it isn't the worst thing that I can think of.


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## humble_pie (Jun 7, 2009)

Market Lost said:


> Equities are definitely loaned out; Blackrock even publishes a PDF about it. My problem with it isn't so much the risk, as it is actually very low. My issue is that the securities are often loaned to short sellers. Still, it's part of the price discovery, and it is supposed to keep management fees low, so it isn't the worst thing that I can think of.



the above is something of a typical attitude. It doesn't mean that risk from securities lending by ETFs does not exist. It simply shows that most folks are indifferent to such risk.

Market Lost may i hone a fine point: you say risk is very low, yet you have an issue with lending securities to short sellers, which you mention is "often" done.

it's true that the borrowers of securities from institutional fund managers including ETF vendors are hedge funds in the process of short selling.

i'm left wondering how is it possible to note "very low" risk when lending to short sellers but at the same time have "issues" with such loans to short sellers?


.


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## olivaw (Nov 21, 2010)

The Vanguard link above (about US stock ETFs) said the collateral (cash) is invested in "high quality" financial instruments. What exactly do they mean by "high quality"? In 2007, CDOs were given AAA and AA ratings. Those "high quality" instruments turned out to be bundles of low quality mortgages on overpriced homes. 

I don't believe that ETFs are unsafe or that lending is inherently bad. I do believe that we need to be skeptical of anything said by investment bankers.


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## james4beach (Nov 15, 2012)

james4beach said:


> Stock ETFs (source: iShares annual report equities)
> 
> XIN 20%
> XSP 8%
> ...


And BMO's flag ship ETF is (source: annual report page 20)

ZCN 9%

That's quite high. If you want to avoid securities lending, XIU seems like the best vehicle among the TSX index ETFs.


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## james4beach (Nov 15, 2012)

olivaw said:


> I don't believe that ETFs are unsafe or that lending is inherently bad. I do believe that we need to be skeptical of anything said by investment bankers.


Agreed. I saw a reference above that the securities lending collateral was purely federal & provincial paper. If that's true, I wouldn't worry so much. Here was that message post showing that there is indeed a page in the financial statements that says the collateral is government paper.

That's really good news, and alleviates my worry. But still, the paper is government paper as of the time of that writing. What will it be later on? Will the requirements be relaxed during a financial crisis, for example? (Govt paper will get a lot more rare during a financial crisis). The whole process is too opaque for my taste.


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## humble_pie (Jun 7, 2009)

olivaw said:


> I don't believe that ETFs are unsafe or that lending is inherently bad. I do believe that we need to be skeptical of anything said by investment bankers.



as it happens my view would be the direct opposite! i think the lending is, if not "inherentlly bad," at least not good, for the simple reason that investors do not even remotely understand that it is going on. Look any day in this forum, one will find a number of posters all devoutly believing that the ETFs they own are holding - in secure professional custody - all of the shares which they claim they are holding.

neither do the investors understand the representational sampling techniques which permit the funds to hold proxies instead of actual stocks, even though - in every case - the utilization of proxies is spelled out in each prospectus.

this brings me to my 2nd disagreement with olivaw, because i for one do tend to trust the investment bankers. These are big firms. Their prospectuses are written by experienced lawyers who know the regulations like the backs of their hands. They respect the regulations scrupulously. They disclose everything that regulations require.

the problem IMHO is that regulations do not require enough disclosure. There is also a matter of communication style. The lawyers' language is dry & tedious. Important data is often not disclosed until page 28 or 42 or 103 ... what investor is going to plow through 27 or 41 or 102 pages of incomprehensible legal boilerplate?

here's an example: mutual fund trailer fees. Twenty years ago, these were unheard of. They were being paid, of course, but nobody knew. It took the journalists - people like jonathan chevreau - to explain to the investing public.

all the while, proper information regarding trailer fees was buried deep in the prospectuses. To find it, readers would have to plow through dozens of pages of legal boilerplate. The result was that the knowledge was ignored. The individual fund salesmen who were selling the funds would certainly never volunteer the information that they themselves were getting paid every quarter as long as an investor would keep holding the fund. 

eventually, reformers - including the journalists who publicized their news - were able to bring about change in the industry. Only a couple of years ago, regulations were finally introduced that now require trailer fees to be prominently discussed in early pages in each prospectus.

however the entire reformation process took more than 25 years.

* * * * *​
it's a similar story with ETF & other fund lending of securities to short-selling hedge funds. There is not yet enough regulation requiring that this information be fully & prominently disclosed to investors. 

it seems obvious to me - plus it's completely acceptable to me - that wealth management firms who are in the business of creating & selling investment products will *not* voluntarily disclose information that does not favour themselves, when such disclosure is not required by securities regulators.

instead, it's up to consumers to ask for this information. Given enough demand, over time, the regulations will eventually change to favour more transparent disclosure.

this leaves the media & even the social media as early messengers of change which is needed to protect consumers. Change that should get underway.

.


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## james4beach (Nov 15, 2012)

I think securities lending out of index ETFs is dishonest to the retail investor. Say you're an investor and you buy $10,000 of TLT, the Treasury Bond Fund. You think to yourself, now I own (through this fund) $10,000 of US Treasury Bonds.

Well think again. TLT at one point had 42% of its assets out on loan, so you really only were holding onto $5,800 of treasury bonds.

I think that's deceptive. The details are buried on page 235 of the financial statements.


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## humble_pie (Jun 7, 2009)

^^



ok we're on a scale. You're over there saying it's dishonest & deceptive to bury critical details on page 235 of an already-difficult-to-read financial statement.

me i'm in the middle saying that until regulations force securities merchants to communicate more transparently, why should they do so? revealing the details upfront is not going to help their business. It might even turn some customers - for example myself - away.

so on they coast, obeying existing regulations to the T, spending millions to advertise & communicate PR propaganda about how ETFs are fail-proof & virtually guaranteed. 

it's up to consumers to ask the questions that will force more transparent disclosure. This is a torturesomely slow process. 

it's a brand-new venture to question the behind-the-scenes securities lending, proxy holding & representational sampling techniques of the ETF vendors. It's probably an effort whose time has not yet come, since by & large people today seem to not be ready to believe that their couch potatoes are anything less than perfect.

i think haroldCrump was 100% prophetic when he posted that it will take the collapse of a big world money centre bank for some of the derivative, short positions & FTD (failure to deliver) histories to be exposed.


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## humble_pie (Jun 7, 2009)

james4beach said:


> Say you're an investor and you buy $10,000 of TLT, the Treasury Bond Fund. You think to yourself, now I own (through this fund) $10,000 of US Treasury Bonds.
> 
> Well think again. TLT at one point had 42% of its assets out on loan, so you really only were holding onto $5,800 of treasury bonds.
> 
> I think that's deceptive. The details are buried on page 235 of the financial statements.



TLT is a US ETF, then?

james4 could u please let us know - for the sake of the wiki - whether canadian ETF financial statements show precisely whether each individual security that is supposed to be held in a fund is actually present or whether it has been loaned out.

last i looked, the Black Rock US ETFs were showing this info on audited annual financial statements, although the data was buried deep. It was also presented in a format that almost nobody could understand (tiny asterisks with no footnoted explanation until pages later) (even then the explanation was in ultra-small type font)

however, the canadian Black Rock ETFs were not showing this detailed data for each security in the holdings page of an audited financial statement.

i deduced from this canadian omission that the US regulator - the SEC - requires such disclosure whereas the much weaker canadian regulators do not.

has this changed over the past year? you did mention upthread that XIU is not lending out anything ... how were you knowing that?

thankx
building the wiki

.


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## james4beach (Nov 15, 2012)

As far as I know, the Blackrock and BMO financial statements do not indicate which individual security was loaned out. All they include is a table that shows the total dollar amount of securities out on loan.

With XIU for example, as of 2015 year end, the "Fair value of securities on loan" (page 283) is 286,577,926
And the fund's total investment assets were 11,134,504,186 (page 3)

From this I conclude that they have loaned out 2.6% of assets

Of course, they could have loaned out far more at any point during 2015, but this is the snapshot at the end of the year


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## humble_pie (Jun 7, 2009)

thankx, your info shows that the situation has not changed.

i think it's hopeful that they publish any info at all, even when it appears on page 283. That's at least a foothold to start working from, when one is seeking greater disclosure.

ottomh the low lending for XIU is astonishing, because those are the TSX largest cap stocks & therefore i'd imagine the easiest to loan. The demand would be insatiable. Of course, as you mention, they *could* have loaned out to a much greater extent throughout the year, then pulled themselves sharply back in order to pose for the annual financial report camera.


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## james4beach (Nov 15, 2012)

I think I can explain XIU's low lending level. Perhaps it's because these are the most liquid stocks in Canada, so they're not particularly rare, which means there is minimal demand to borrow them. As a short seller with IB, I remember that before I shorted a stock I'd look at its general availability ... less liquid, more obscure stocks are less available and for them I would pay to borrow (minimal supply). It's a supply/demand issue.

But if you want to borrow shares of TD or CNR, the shares are so easily available... everywhere... lots of supply and no need to pay to borrow. XIU contains all of the most readily available stocks, and they are available from so many sources. Lots of supply.

XIN on the other hand contains a bunch of European stocks, tougher to get your hands on. More incentive for the fund to lend out the shares for a fee. The same goes for government bonds. Lots of demand for these, so the funds are motivated to lend out the securities.

XCS (smallcap index) has loaned out a whopping 30% of their fund!

Which also makes sense. TSX small caps are more rare, hard to find. Thus XCS, who has a portfolio of tons of the shares, has an incentive to loan out the securities for a fee.


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## olivaw (Nov 21, 2010)

humble_pie said:


> this brings me to my 2nd disagreement with olivaw, because i for one do tend to trust the investment bankers. These are big firms. Their prospectuses are written by experienced lawyers who know the regulations like the backs of their hands. They respect the regulations scrupulously. They disclose everything that regulations require.


We'll disagree on investment bankers humble - or more specifically investment banking firms. As I said earlier, investment bankers developed the CDOs and derivatives that created the financial crisis of 2007. Evidence suggests that most of the staff had no idea what it was they were dealing. Lehman Brothers is an example. 

I'm not following your point about disclosing everything that regulations require. If they are not required to disclose relevant information (some of which may be harmful) then failure to disclose it will legal. If they don't understand the product then the lack of disclosure could even be honest. In both cases the consumers of the products need to be sceptical. Is there something that I am missing? 



PS: James, Humble and others, please keep posting. I find the discussion about derivatives and lending interesting.


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## humble_pie (Jun 7, 2009)

james4beach said:


> I think I can explain XIU's low lending level ...



by Jove you've got it!

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## humble_pie (Jun 7, 2009)

.

to keep things in perspective, i think the probability of an above scenario happening is extremely low to low.

not that my opinion matters, but i'd put the long-term probability somewhere in the 10-30% range at present. The immediate probability would be much lower, nevertheless i believe that both short & long-term probability has increased slightly in recent years as chinese, european & russian banks have weakened.

one should keep in mind that limited or isolated versions of the above are far more likely to occur than a total global financial collapse. In an isolated instance, banking networks would help to make good the losses & these would - we presume - be limited. 

one can scoff at the idea of an armageddon global financial collapse, but that is preciselly what the world squeaked to within a hairsbreadth of in 2008/09. Only 7 years ago. Parties who scoff don't understand how serious the danger was at that time.

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## mordko (Jan 23, 2016)

Gee. Nice but baseless conspiracy theory. If loans can be recalled instantaneously at regular intervals just to manipulate reports then these is rather safe lending. 

Firstly, all ETFs publish semi-annual reports and many publish quarterly reports. Secondly, respectable companies publish continuity information within annual reports, which includes monthly data. Lastly, they have to include securities lending income for the year, so if there is a specific concern one can easily see if manipulation of the sort you described is going on.


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## humble_pie (Jun 7, 2009)

mordko said:


> Firstly, all ETFs publish semi-annual reports and many publish quarterly reports. Secondly, respectable companies publish continuity information within annual reports, which includes monthly data. Lastly, they have to include securities lending income for the year, so if there is a specific concern one can easily see if manipulation of the sort you described is going on.




alas the above is false. As has been painstakingly set forth above, there is nothing in the monthly, quarterly or unaudited semi-annuals that conveys accurate information with enough detail to properly inform investment consumers.

US ETFs contain slightly more detailed information in audited statements only, but the same is unreasonably difficult to find.

canadian regulators, meanwhile, are allowing the veiling of this specific security-based data which appears in US audited financial statements.

i'm left wondering what mordko would know, actually. As of a day ago, his post shows that he was unaware of any ETF securities lending whatsoever. It appears that his subsequent reference had to be supplied to him by his mentor .:biggrin:


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## olivaw (Nov 21, 2010)

Canadian Couch Potato discussed ETF lending in 2011. http://canadiancouchpotato.com/2011/11/14/etf-risks-in-perspective-securities-lending/ The article is a little old now, but it provides some decent basic information. 

etf.com discusses it *here*.



> You’d think the biggest risk in securities lending is that the short-seller you lent shares to goes bankrupt. Fortunately, industry practice is for borrowers to provide collateral exceeding the value of the loaned securities by a set margin. So while a busted counterparty is a pain, it’s not immediately costly.
> 
> The costs come in if the borrower is a short-seller (it usually is) and the security that he or she shorted rallies strongly in a single day, the borrower defaults and the provided collateral is insufficient to cover the cost of reacquiring the security. Remember, collateral balances are only settled (at best) daily.
> 
> ...


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## mordko (Jan 23, 2016)

Oh, yeah, "mentor"... Who would that be? I think HP is going for the Guinness book of records to try and produce a brand new conspiracy theory in every sentence and ever next one has to be even dumber than the predecessor. Impressive record so far.


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## mordko (Jan 23, 2016)

olivaw said:


> Canadian Couch Potato discussed ETF lending in 2011. http://canadiancouchpotato.com/2011/11/14/etf-risks-in-perspective-securities-lending/ The article is a little old now, but it provides some decent basic information.
> 
> etf.com discusses it *here*.


That's a good article, also interesting links to Jason Zweigs WSJ articles. It's very clear that we know exactly how much lending is going on for the obvious reason that any income is reported, what we don't know is how much of the income is directed back to ETFs. Zweig gives an example of irresponsible use of collateral. Also everyone seems to be praising Vanguard of giving income to investors which is aligned with what Vanguard is declaring.


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## james4beach (Nov 15, 2012)

mordko said:


> It's very clear that we know exactly how much lending is going on for the obvious reason that any income is reported


No, securities lending income doesn't tell you "how much" lending is happening.

They could lend out few assets at high interest rates, or lend out many assets at low interest rates. Then there's the question of how long it's out on loan.

The income tells you is whether or not lending is happening and that's about it. The tables that show the fair values on loan just tell you the loaned amounts at the snapshot of the report date.

The remaining mysteries are: _which_ securities were actually loaned out? At what times? For how long?


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## mordko (Jan 23, 2016)

james4beach said:


> No, securities lending income doesn't tell you "how much" lending is happening.
> 
> They could lend out few assets at high interest rates, or lend out many assets at low interest rates. Then there's the question of how long it's out on loan.
> 
> ...


James, OK, not "exactly", but you can figure out how significant the lending is based on income. If you look at reputable ETF vendors such as Vanguard, you will find that the answer is "negligible". 

And if you, like HP, believe that the vendors are recalling loans just for the annual report and then deliberately lying about what's on loan in semi-annual/quarterly reports... Well, then the possibilities become infinite. 

The real question is how much income from this activity is returned to investors.


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## humble_pie (Jun 7, 2009)

james4beach said:


> No, securities lending income doesn't tell you "how much" lending is happening ...
> 
> The income tells you is whether or not lending is happening and that's about it. The tables that show the fair values on loan just tell you the loaned amounts at the snapshot of the report date.
> 
> The remaining mysteries are: _which_ securities were actually loaned out? At what times? For how long?




there is a difference between US & canadian fund lending reportage, evidently due to the slightly more stringent disclosure requirements of US regulators vs the still-too-lax requirements of canadian regulators.

US audited financial statements show faint trace marks on individual securities in a fund which are out on loan at the time of preparation of the audited report. These faint trace marks are typically buried dozens or hundreds of pages deep in the audited annual financial statements. They consist of tiny asterisks added to each loaned security.

pages later - typically in tiny footnote-sized script - so tiny as to be unreadable - comes the terse explanation that an asterisk means the security is out on loan.

never mind that this US disclosure is inadequate. Never mind that 99% of investors are unable to find the information or are unable to understand what the tiny asterisks mean even if they would happen to stumble upon them.

much sadder is the fact is that canadian regulators are not yet enforcing disclosure of even this minimal information. 

it is absurd to pretend that canadian ETF investors are going to apply complex netting out formulas on line items in financial statements in order to discover the total amount of fund lending by a particular fund. This is not proper disclosure, which is supposed to be in languagge that ordinary investors can understand.

in canada, 99.99999% of investors will have not even know that their ETF might be lending out up to one-third of its securities.

.


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## humble_pie (Jun 7, 2009)

.

here is a valuable academic paper from the Bank for International Settlements - this is the Swiss-based global bank-of-last-resort that serves to support the western banking system - on how derivative strategies in exchange-traded funds can de-stabilize global financial markets.


from the Abstract:

_Crisis experience has shown that as the financial intermediation chain lengthens, it becomes complicated to assess the risks of financial products due to a lack of transparency as to how risks are managed at different levels of the intermediation chain.

Exchange-traded funds, which have become popular among investors seeking exposure to a diversified portfolio of assets, share this characteristic, especially when their returns are replicated using derivative products.

As the volume of such products grows, such replication strategies can lead to a build-up of systemic risks in the financial system.

This article examines the operational frameworks of exchange-traded funds and identifies potential channels through which risks to financial stability can materialise._ 


http://www.bis.org/publ/work343.pdf


.


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## mordko (Jan 23, 2016)

Derivatives are a whole other matter. IMHO ETFs using derivatives on a significant scale should be avoided by people trying to build their retirement portfolios.


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## olivaw (Nov 21, 2010)

humble_pie said:


> .http://www.bis.org/publ/work343.pdf


Good read. I also avoid products that use derivatives because I am not smart enough to assess the risk. 



> Synthetic replication schemes transfer the risk of any deviation in the ETF’s return from its
> benchmark to the swap provider, which is effected by entering into a derivatives contract to
> receive the total return of the benchmark. This protects investors from the tracking error risk
> which physical replication schemes would otherwise expose them to. However, there is a
> ...





> Some structures may employ multiple swap counterparties for the transaction. The
> composition of the assets in the collateral basket can change daily ...


:eek2: :eek2: :eek2: :eek2:


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## humble_pie (Jun 7, 2009)

.

it's not possible to determine the extent of derivative usage in any one fund.

regulators in both canada & the US permit representational sampling, option trading & other proxy practices without requiring that tangible evidence of such practices be included in audited holdings statements.

what does that mean? it means a fund with synthetic derivatives representing part of its alleged holdings, is still allowed to claim the full list of alleged holdings as if it actually did hold each named security in full.

where does one look to find out if a fund holds derivatives? in the prospectus. The boilerplate will accuratelly spell out that the fund is engaged in representational sampling, option trading, futures trading, etc.

what this means is that a party wishing to research a fund must read the financial statements in order to find out if the fund is lending securities & must also read the prospectus in order to find out if the fund is trading derivatives.

quite an assignment. I don't know anyone other than james4 who regularly does the above.

from the BIS study cited above:

_Exchange-traded funds, which have become popular among investors seeking exposure to a diversified portfolio of assets, share this characteristic [lack of transparency] especially when their returns are replicated using derivative products._


.


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## Market Lost (Jul 27, 2016)

humble_pie said:


> the above is something of a typical attitude. It doesn't mean that risk from securities lending by ETFs does not exist. It simply shows that most folks are indifferent to such risk.
> 
> Market Lost may i hone a fine point: you say risk is very low, yet you have an issue with lending securities to short sellers, which you mention is "often" done.
> 
> ...


There is also risk that the underlying securities will become worthless. These loans aren't being made without collateral, just as if you borrow from a bank, which is why I say the risk is low. I'm not indifferent to it, I'm just suggesting that if you obsess over every risk then why even invest? 

I have issues with short sellers after having lived through the melt-down and seeing the way they behaved. Quite frankly a lot of them are low life scum. They would take out CDS on banks, spread rumours about the banks, then use the fact that they were doing it as evidence that the banks were in trouble. It's like taking life insurance out no your uncle, and then telling everyone how bad he looks. This is actually illegal, but nobody went to jail, just like how the bankers with their toxic CDO should have done the perp walk, but never did.


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## Market Lost (Jul 27, 2016)

humble_pie said:


> ^^
> 
> 
> 
> ...


I 100% agree with you that it needs to be transparent. Unfortunately, considering how long its taken just to have mutual fund fees fully disclosed in plain dollar costs - something like 20 years - it is going to be incumbent on the investor to figure it out. I don't agree with this, but this is the reality.


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## james4beach (Nov 15, 2012)

humble_pie said:


> regulators in both canada & the US permit representational sampling, option trading & other proxy practices *without requiring that tangible evidence of such practices be included in audited holdings statements.*
> 
> what does that mean? it means a fund with synthetic derivatives representing part of its alleged holdings, is still allowed to claim the full list of alleged holdings as if it actually did hold each named security in full.
> 
> where does one look to find out if a fund holds derivatives? in the prospectus.


Thanks for spelling this out, humble_pie. I was not aware of this. I thought that when I looked at the audited financials and saw a listing of each stock name and dollar amount, that this literally meant that the fund held shares in each of those stocks.

You're saying that if the fund uses some kind of representative sampling or index approximation strategy, then this list of securities might not be literal. It may be the unwrapped effect of some kind of abstraction. And you're saying that the abstraction -- futures/options/swaps -- are not actually spelled out in the audited financial statement?


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## mordko (Jan 23, 2016)

Guess we are done with the BS about secret lending and moved onto another BS? 

I mean... Sure, synthetic, alternative funds and ETFs use derivatives. Also ETFs hedging currency etc. It's NOT a secret! When they use derivatives, ETFs report it. Reporting requirements vary, in the US one can find this info in N-CSR forms. Reporting of derivatives is required under section 18 of the company act.

There may be some non hedged vanilla index ETFs, which form part of couch potato strategy, that use derivatives but if so the use is negligible. We are talking a fraction of 1%. Anyone can find it out. Vanguard ETFs which I tend to hold do not use options, swaps, currency forwards or futures.


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## humble_pie (Jun 7, 2009)

mordko said:


> Sure, synthetic, alternative funds and ETFs use derivatives. Also ETFs hedging currency etc. It's NOT a secret! When they use derivatives, ETFs report it.



no, funds do not report this information. Not in the kind of transparent, clear, easily-findable up-front manner which consumer advocates in the financial sector are demanding. Reform movements are lagging far behind, by a number of years, but transparent-clear-easily-findable is the direction in which the regulators are slowly moving.







mordko said:


> Reporting requirements vary, in the US one can find this info in N-CSR forms. Reporting of derivatives is required under section 18 of the company act.



the above is a good example of the dysfunctional defences which some ETF salesmen are attempting to raise in order to defend the non-disclosing status quo.

what Mom or Pa Investor has even heard of form N-CSR, let alone would know where to look to find it.

what Mom or Pa Investor ever reads company act legislation, or would know where or how to find it.

individual investors are to be helped, not forced to jump through hoops by financial salesmen. This is my religion.




*The goal of the consumer advocates is extraordinarily modest. The goal is to keep on politely requesting that accurate pertinent information be made available to all financial consumers in a transparent, clear & easily-findable manner.*


.


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## mordko (Jan 23, 2016)

It's irrelevant whether consumers are aware of all reporting forms. The point is that "consumer advocates" have the tools to disprove their interesting theories and discover that vanilla couch potato non hedged index ETFs don't use derivative strategies. If VTI or VBR were to start investing in derivatives, it would be picked up in no time and make major news. In any case, Synthetic or hedged ETFs clearly describe themselves as such in all materials, one just needs to read.


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## humble_pie (Jun 7, 2009)

mordko said:


> It's irrelevant whether consumers are aware of all reporting forms.


strongly disagree
in addition, regulators are slowly moving in the opposite direction, ie towards greater transparency





mordko said:


> If VTI or VBR were to start investing in derivatives, it would be picked up in no time and make major news.


strongly disagree
i doubt that any "major news" these days - in these times of extraordinarily hard major news - could ever be caused by a little old exchange-traded fund
let us not get carried away with self-importance .each:





mordko said:


> In any case, Synthetic or hedged ETFs clearly describe themselves as such in all materials, one just needs to read.


strongly disagree
this is the whole point
at the present moment, as evidenced upthread, partial disclosures are only obscurely referenced in complex legal or accounting boilerplate located in the far rear pages of statements & prospectuses.
these are documents that Mom & Pa Investor are never going to read.



what is being sought is transparent, clear, full & fair disclosure that, for the sake of middle-class investors, needs to be presented in the up-front reading material on websites & in printed sales materials.

as noted upthread, the exact same story has successfully concluded with respect to presenting mutual fund trailer fee information.

but it took consumer advocates more than 20 years to bring this about.

the consumer advocacy organizations involved - FAIR canada & stephen jarislowsky's council for good governance among them - will gladly relate how the vast & highly organized mutual fund industry fought their reform efforts every step of the way.

.


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## mordko (Jan 23, 2016)

Alright, show me you are not making up wild theories out of thin air. Give one example of plain vanilla non-hedged index-tracking Couch Potato ETF which holds more than a fraction of 1% of options, futures, currency swaps etc. 

Because otherwise you just making it up as your other 100% fake claims (e.g. Canada is banning dual nationality). In general spreading false and baseless information and scaremongering is not helpful, although anyone who would listen to you has only themselves to blame.


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## humble_pie (Jun 7, 2009)

mordko said:


> Because otherwise you just making it up as your other 100% fake claims (e.g. Canada is banning dual nationality). In general spreading false and baseless information and scaremongering is not helpful, although anyone who would listen to you has only themselves to blame.



lol i never said canada is looking to ban dual nationality.

repeat: i *never* posted that canada is looking to ban dual nationality. Mordko is making that up, along with all his other hysterical accusations against myself & other cmffers.

what i actually said is that canada is considering blocking citizenship for *multiple* citizenship holders. I used the word *multiple.*

look in any media. At least every week there is news re what are referred to as "citizens of convenience." These are citizenship consumers who perambulate the planet, hoovering up citizenships in the hopes of gaining as many social, political & economic advantages for themselves as possible.

in the recent past, quebec has been especially vulnerable to citizenship shoppers "of convenience" from the middle east & north africa who have established their wives, children & aging seniors here in order to benefit from quebec's exceptionally high child rebates & senior financial benefits. Evidently these are the highest in the world at present. Higher than any other canadian province. Surprisingly, higher even than scandinavian countries.

typically the father remains behind in the country of origin to run his business interests. In other cases the father will appear to "live" in this country but in reality he travels frequently to operate his business interests in the country of origin. In canada, such a father will typically declare only enough money & income to get the family into this country. In other words, he is a tax cheat as well.

mohammad shafia, who would drown 3 of his daughters plus his first wife in the Kingston locks, was one of these unpleasant immigrants. Shafia's real business centre was in dubai, where he commuted frequently to operate an extensive automotive dealership network. At the time of his incarceration as guilty for murder, newspaper reports recounted how his greatest anxiety was getting his 2nd son - the oldest son was imprisoned under the Kingston locks murder conviction - Shafia's greatest energy in jail was not spent in remorse but on getting the 2nd son to run the dubai business interests.

evidently there are numbers of similar stories in vancouver. Evidently a significant number also in toronto. The stories are legion. The grandparents are in residence. The children are in residence. Sometimes the mother is in residence. But the father is rarely seen in this country.

i for one am 100% against opportunistic multiple citizenship shoppers aka *citizens of convenience.* I would like to see citizenship applicants who already possess 2 or more foreign citizenships barred from becoming canadians, save & except in special individual cases which would require a cabinet minister's permit. Such exceptional cases would nearly always turn out to contain proven refugee elements in their dossiers.

in summary, nothing i have ever said, nothing the federal department has ever whispered, raises any doubts over dual citizenship. It is the well-known multiple citizenship "convenience" shoppers who are under consideration.


.


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## mordko (Jan 23, 2016)

Wow. Impressively long-winded BS. 

HP:


> lol i never said canada is looking to ban dual nationality.


HP:


> canada btw is beginning to move towards blocking multiple citizenships.


Wikipedia:


> Multiple citizenship, also called dual citizenship or multiple nationality, is a person's citizenship status, in which a person is concurrently regarded as a citizen of more than one state under the laws of those states.


Of course the point on dual vs >than 2 is moot because Canada "isn't beginning to move towards blocking" either. 

Crucially, I note that you did not provide a single example of an index-tracking ETF which invests a non-neglibile $s in derivatives. As such I take that all your rants above are exactly the same BS as your claim on Canada blocking dual citizenship and the rest of them.

P.S. What do you have against capital letters? Do they not have the right blood type?


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## humble_pie (Jun 7, 2009)

.

in this document, Vanguard confirms that it uses several sampling & substitution techniques - which it calls *optimization* techniques - to replicate indexation in its funds.

notice that this Vanguard document is only allowed to be given to financial advisors. It is *not* supposed to be given to ordinary investors, although these are the very investors who need to learn about this important information.

https://www.vanguardinvestments.dk/documents/index-fund-brochure.pdf


notice also the reference to the manager's skill at picking proxy samples to manage the risk characteristics of the index he is attempting to track.

to my way of thinking, this puts a whole new spin on passive index investing. Can these lists including synthetic holdings truly be termed *indexes* any longer? when in fact they are not the pure index holdings but rather skilfully groomed suites of securities which include derivative products?


from the Vanguard document:

Tracking methodology

_We implement portfolios based on full replication techniques where possible as this is the ‘purest’ form of indexing and results in lower tracking error. Where necessary, due to fund size, illiquidity in the market or a low number of issues, we may seek to use replication, optimisation or a hybrid of the two_, 


Index methods at a glance


Full Replication

_Buy all securities in the benchmark index
Ideal index tracking technique
Typically results in lower tracking error_


Optimisation

_Buy a representative sample of securities that will replicate the risk and return characteristics of the target benchmark
Better suited to benchmarks that hold an unmanageable number of issues or contain illiquid securities 
Manager’s skill in matching risk characteristics of benchmark is important_



Hybrid

_Buy as many of the securities of the index as possible
Use optimisation to track illiquid securities_


for the record, may i mention that i am not opposed to any of the above practices. All that i question is the veiled coverup. Other ETF vendors - Blackrock is another one - also have similar hidden material on lending & derivative practices which they only make available to advisors.

since the vendor firms such as Vanguard know very well that many of their ultimate fund owners are DIY investors who buy through discount brokers & have no advisors, this restrictive practice appears to be highly disrespectful, to say the least.



.


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## mordko (Jan 23, 2016)

This document is on the web. How exactly is this a "cover-up"??? 

The word "synthetic" which you are using isn't mentioned even once in the whole document. "Synthetic" does involve use of derivatives. In fact, this document says the exact opposite - they use full index replication whereever possible. What on earth is wrong with that? How else would you like them to replicate the index? 

Vanguard publishes other materials, including the exact content of it's funds. Other ETFs do the same thing; it's the only way to ensure the pricing is accurate and a regulatory requirement for ETFs. Active ETFs are required to publish daily. 

Here are current VTI's holdings: https://www.etfchannel.com/lists/?a...=&symbol=VTI&sortby=&reverse=&rpp=20&start=25

Yes, there will be times when they are transitioning between indices, including new categories, etc... which will require other techniques - the brochure you linked explains how. And?

The point you made was that ETFs use derivatives (options, futures, etc...) and that they are hiding this. It's a demonstrably false claim. Vanilla, tracking ETFs don't do that other than for a small fraction of one percent to deal with special circumstances. When they do it, information enters public domain. Other fancy ETFs which hedge or try to reflect commodities certainly use derivatives. They have no choice and if you don't understand it then you have no business buying them in the first place. It's all in the open. 

The fact that some brochures are designed for financial advisers rather than general public - yeah, that's awesome! However did you manage to find that? Great investigative journalism. You should go to CNN with this piece of information. New York Times are bound to place it on the front page. 

Just wow.


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## mordko (Jan 23, 2016)

Here is another neat summary from Vanguard explaining various tracking techniques, advantages and disadvantages:

https://advisors.vanguard.com/VGApp/iip/site/advisor/etfcenter/article/ETF_HowETFIndexed

Highly confidential material, don't tell ANYONE, OK?


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## mordko (Jan 23, 2016)

And by the way, deviation from indices causes tracking errors. Again, the information is widely available and should be reviewed by anyone buying a particular product. That's how we check if the managers for our vanilla tracking ETFs do a good job. Going above the index is just as bad as going under, any significant tracking error beyond fees is bad - full stop. There is simply no way for an index-tracking non-hedged ETF to invest 30% in fancy derivatives without declaring it and everyone and his dog taking notice.


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## james4beach (Nov 15, 2012)

CanadianCapitalist's interview with Vanguard says that Vanguard fixed income ETFs don't use securities lending. Is this still true?
http://www.canadiancapitalist.com/qa-with-vanguard-canada/

Here's list of some Canadian bond ETFs and the securities lending amounts, taken from here
http://www.greatponzi.com/articles/20160823-bond-etf.html

Performance is the 1 year to end of July 2016


ETFDescriptionTermFeesSecurities lending1 yr returnVSBShort-term generic3 yrs0.11%0%1.27%VSCShort-term corporates3 yrs0.11%0%1.71%XSHShort-term corporates3 yrs0.14%0%1.84%VABGeneric bond fund11 yrs0.13%0%4.63%ZDBDiscount bond fund10 yrs0.22%18%4.41%


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