Fund Competition at the Zero-Fee Bound

Abstract

Security lending frictions transfer informational rents from short-sellers to asset management funds and investors, who may receive dividends or fee discounts. While state-contingent dividends correlate with shorting demand and provide a natural hedge, fee discounts do not. Ex-ante fee discounts are optimal only if funds can funnel revenues ex-post. Therefore, zero-fee contracts reflect moral hazard. Generally, technology-led drops in fund expenses improve stock market participation. The relationship breaks down for zero-fee opaque funds, as asset managers capture the full returns to technology. To reduce funnelling of lending revenues, costs needs to decrease beyond the point where zero fees become sustainable.

Keywords: asset management, security lending, robo-advisors, moral hazard

JEL Classification: G11, G14, G23