Distortions Caused by Asset Managers Retaining Securities Lending Income
55 Pages Posted: 6 Dec 2017 Last revised: 31 Oct 2018
Date Written: October 1, 2018
Using newly-mandated disclosures, we show fund managers often retain a fraction of securities lending income by employing in-house lending agents at above-market rates. This retention incentivizes fund managers to overweight stocks with high lending fees. In a heterogeneous agent model, we show this incentive distorts equilibrium portfolio choices, fund performance, and asset pricing. We confirm our model's predictions empirically: fee-retaining active mutual funds overweight high lending fee stocks, underperform, and charge lower management fees. Our model also offers a new explanation for the negative relation between lending fees and future fee-inclusive returns.
Keywords: Share lending, short selling, mutual funds, ETFs, incentives, asset management
JEL Classification: G11, G12, G23
Suggested Citation: Suggested Citation