Distortions Caused by Lending Fee Retention
58 Pages Posted: 6 Dec 2017 Last revised: 16 Jun 2023
Date Written: June 16, 2023
Some mutual funds retain a fraction of securities lending income by employing in-house lending agents. In a model with heterogeneous investors and endogenous delegation to mutual funds, we show a subset of funds optimally engage in lending fee retention and, as a result, overweight high lending fee stocks that endogenously underperform. We find empirical evidence consistent with our model's predictions: active mutual funds we identify as fee retainers invest more in high-fee stocks and underperform relative to both non-retaining and non-lending funds. We also show fee retention helps explain the negative relation between lending fees and future fee-inclusive stock returns.
Keywords: Share lending, short selling, mutual funds, incentives, asset management
JEL Classification: G11, G12, G23
Suggested Citation: Suggested Citation