Until recently, the leader in index ETFs for US stocks has been Vanguard. Their great reputation combined with rock-bottom MERs has made them the clear choice. However, Schwab has come out with several index ETFs with management fees matching or beating Vanguard with the added bonus of paying no commissions when trading in a Schwab account.
As Larry MacDonald points out, some ETF companies generate extra revenue through a practice called securities lending. This is the practice of lending stock to short sellers for a fee.
Some commentators are speculating that Schwab is keeping the proceeds from securities lending to augment the MER. The Schwab prospectus doesn’t seem to clear up the matter:
“When the fund lends portfolio securities ... the fund will also receive a fee or interest on the collateral. ... The fund will also bear the risk of any decline in value of securities acquired with cash collateral.”
So the fund gets a fee and the fund bears the risk. What do they mean by “fund” in this context? Is it the unit-holders or the management company?
In my opinion, because unit-holders own the securities they should keep the proceeds of securities lending (net of reasonable costs). If a management company keeps some or all of the proceeds, then they are essentially understating the fund costs.
Until Schwab makes it clear who gets the securities lending proceeds, I’ll stick with Vanguard. Vanguard has a clear policy:
“Unlike other firms that allocate a significant portion of lending revenues to their management companies, Vanguard returns all lending revenues, net of broker rebates, program costs, and agent fees, to the funds. Other securities lenders may divert up to 50% of the revenues derived from their securities lending programs.”