Gyroscopic Investing

As a general strategy what I think Wall Street does is to quitely interlink everything and everyone. Then engage in some bonkers Russian Roulette lottery scheme, take the loot whilst it works and then when it inevitably comes up tails, insist on a bail out pointing out that if any one of them go down, they will take everyone else down too.

Stone,

This subject seems to have gotten some attention here and there, but your bringing it up in the gold discussion is what prompted this.

Thanks for the heads up.  I was completely unaware.

I think this also justifies maybe splitting your stock fund holdings into a few different total stock market funds.  I am more concerned about bonds, but if this is common mutual fund practice I think we need to look harder at institutional diversification.

That said, an event that would likely bring these contracts into question could very likely threaten the whole system, no matter what fund you have.

After mulling it over a bit, this is really just another example of counter party risk.  And virtually EVERY investment, aside from holding physical gold, cash, etc., has counter party risk.  I would even argue that Treasury Direct has a bit of counter party risk.

Don't many brokerages loan out their customer's shares of stocks/ETFs?  I don't know about holdings of individual bonds, but couldn't they be loaned too?

In the end, if you want to invest you have to trust some entity to hold your investments and do more or less (hopefully more) what they said they were going to do. 

I can confirm that the Statement of Additional Information for many of Vanguard's Index Mutual Funds say the same thing about up to 1/3 of securities being lent.

Oddly enough though, if you read the FAQ document iShares has for IAU, it states on the third page:

Does the Trust lend or have the ability to lend gold from the portfolio?
No. The custodial agreements do not allow lending, and the Trust does not lend gold from the portfolio.

Wild,

I would say that this is a whole other level.  I would really hope that your brokerage can't lend out individual stocks and bonds that you own, and they are just in custody of.  Further, if Vanguard goes bankrupt, you still own the physical contents of your account.  I'm not sure what the process of transfer is at that point, but it's much more difficult to walk your way through a case where you lose your assets.

Funds are quite different, in that you are simply owning a share of all the activity in that fund, with all the bs that it implies.

I'd say that a fund managed by a company as large as i-shares that simply bought treasury bonds and sold you a share in the ownership of those bonds is in a whole different camp of potential systemic risk than one that does that but then engages in security lending.

The very nature of lending bonds to people that are making bets against those bonds indicates a much higher chance of instability in the fund, IMO.  If all you do is hold assets that rise and fall in value with along with your clients' claim on those assets, there's no real room for huge problems.  If you are lending those assets to people who are betting the opposite way that your fund is (and the fund is therefore somewhat exposed to the losses the  shorters are exposed to), you don't have to get too creative to imagine a fund collapsing, or at the very least coming up short, which could cause panics, and lead to huge problems anyway.

If Vanguard can do this with our individual bonds I will be 1) utterly appalled, and 2) thinking of ways to avoid that risk but still own these in a tax-deferred account.

rhymenocerous,

I'm starting to have more faith in gold ETFs that simply hold the gold you are buying than these bond funds.  At least the ones that simply trade futures are doing it on the surface so the risk is apparent.

I'm about at the "a little knowledge is dangerous" stage here, but I think any short sale implies lending of securities (stocks, bonds, ETFs, etc.).  And all of these can be shorted (touted as one of the "benefits" of ETFs).

And I agree this is potentially an extreme counter party risk.

I did a quick check of a few Vanguard SAIs and did't see anything on securities lending.  Rymenocerous, which funds did you find mention of lending?

Regarding IAU and gold lending, GTU is prohibited from lending its gold holdings as well.

WildAboutHarry wrote: After mulling it over a bit, this is really just another example of counter party risk.  And virtually EVERY investment, aside from holding physical gold, cash, etc., has counter party risk.  I would even argue that Treasury Direct has a bit of counter party risk.

Don't many brokerages loan out their customer's shares of stocks/ETFs?  I don't know about holdings of individual bonds, but couldn't they be loaned too?

In the end, if you want to invest you have to trust some entity to hold your investments and do more or less (hopefully more) what they said they were going to do.  

I agree. At the same time, I'm glad the OP (moda) found this. I have about 35% of my long bonds in TLT (with 53% held directly via Fidelity and 12% in EDV). I'd like to get more bonds in my Vanguard space, but I think the minimum purchase is 10K, which makes it inconvenient. So, I hold ETFs there.

To paraphrase Wild About Harry above, you pay your money and you take your chances.

dualstow,

stone gets the credit on this... he brought it to my attention.  I was just pissed enough in my populist rage to start a thread about it.

I guess I figured I was late to the party.

Turns out most people didn't know about this.

Can you give me (or direct me to) a rundown on how to buy these on Vanguard.  My dad has a lot of his money tied up in TLT on Vanguard and I want to pull a good chunk out and leave TLT just for trading purposes on the top end.  How much is it?

Further, I never thought a .15% fee seemed high, but it's 5% of the interest paid out in a year, and on $100k of wealth could amount to $150 of fees that could be a night out with the family.

WildAboutHarry wrote:Rymenocerous, which funds did you find mention of lending?

I downloaded the SAI for the Total Stock Market Fund, but I think it covers a list of other Index funds too, listed in the first paragraph.  It's a 56 page PDF, and on page 14 there is a section titled "Securities Lending," much like the one quoted for iShares TLT.

Few people ever read the prospectuses and almost nobody reads the SAIs. I have noticed that the SAIs tends to have far more details on the dirty practices than prospectuses do.

l82start wrote:can you put the treasury bonds in a RothIRA or IRA or do they need a separate/special account to hold them?

No special account needed. Retirement accounts are an excellent place to hold your Long Term Treasuries.

When I looked into starting a PP, I thought that the physical gold etfs seemed OK but that the only stock funds I trusted were investment trusts (closed end funds) and the only way I wanted to hold bonds was directly. With UK treasury bonds there is no minimum purchase amount and they can be bought in approx £1 increments so there is no convenience issue. To my mind a key problem with any open ended fund (such as an etf) is that net redemptions or inflows could put it under a lot of stress. It would have to scrabble around trying to fire sale or get hold of the underlying securities possibly just when doing so was most difficult.

Benko wrote: I use Scottrade since they are cheap.  I have only been investing for a month or so (less time than I've been on this forum) unless you count letting things sit in my retirement account all in the money market "option", and in my checking account (don't ask).

I can do what I need to for investing, but would STRONGLY prefer to make things as simple as possible.  Having long term bonds in some online fund that I never have to touch is simpler than buying the bonds, selling them (was it every 5 years?) and keeping track of the piece(s) of paper.  Life is complicated enough.  I realize that sounds nuts, but that would be my preference if it didn't increase risk significantly.

Thanks for your help.

I've posted that tutorial for you.

http://gyroscopicinvesting.com/forum/ht ... ic.php?t=0

I would imagine that Scottrade's process is somewhat similar.You can also call Scottrade to walk you through the process of buying Treasury Bond on their website, once you feel comfortable with the idea of owning bonds directly.

I did a quick check of a few Vanguard SAIs and did't see anything on securities lending.

Turns out that Vanguard SAI and Prospectus PDFs on line are "dead" i.e. not searchable.

The "Securities Lending" section seems to be a part of many, if not most, Vanguard funds.  Probably the case for most funds and fund families, I suppose.

Does anyone know for sure if brokerage account assets are "lendable"?

Gumby wrote:

l82start wrote:can you put the treasury bonds in a RothIRA or IRA or do they need a separate/special account to hold them?

No special account needed. Retirement accounts are an excellent place to hold your Long Term Treasuries.

thanks !

From the cover page of Vanguard's SAI for its fixed-income funds:

Statement of Additional Information Text Changes

In the Investment Strategies and Nonfundamental Policies section, the following sentence is added as a third paragraph at the end of Securities Lending.

Pursuant to Vanguard’s securities lending policy, Vanguard’s fixed income funds are not permitted to, and do not, lend their investment securities.

Sounds promising for Vanguard's fixed-income funds, maybe? But the SAI for its stock funds appears to make no such statement prohibiting securities lending.

is EDV a "fixed income fund"?

murphy_p_t wrote: is EDV a "fixed income fund"?

I would guess yes, because in Vanguard's overview page for EDV, it says the ETF advisor is "Vanguard Fixed Income Group."

However, the trust aspect is confusing. EDV appears not to be part of the "Vanguard Fixed Income Securities Funds" Trust. It is part of the "Vanguard World Fund" Trust, which appears to be decidedly not fixed-income in its focus--it's full of sector stock index funds, along with a few other stock funds.

So EDV's advisor is the Vanguard Fixed-Income Group, but it's part of a trust comprised mainly of sector stock index funds. That's a bit... confusing :-/

To summarize:

I-Shares treasury bond funds can engage in securities lending with a portion of the fund's holdings;

Vanguard Funds and ETFs can, in general, engage in securities lending with a portion of the fund's holdings, but this is prohibited for fixed-income funds;

With I-Shares Treasury Funds you have a nearly pure treasury fund with additional counterparty risk.  With Vanguard "Treasury" funds you have at least an 80% Treasury fund, with the potential for up to 20% agency, mortgage, and other stuff.

Unanswered:

Can brokerages engage in securities lending with client's holdings (i.e. stocks, etfs, bonds)?

Wild about Harry "Can brokerages engage in securities lending with client's holdings (i.e. stocks, etfs, bonds)?"

I think I heard somewhere that with margin accounts they can but with other accounts they can't? I'm in the dark on this though.

I am Canadian, so I hold ZFL (BMO Long Federal Bond Index ETF).
The prospectus seems to indicate that it too engages in lending.

A BMO ETF may, in compliance with NI 81-102, lend securities to securities borrowers acceptable to it
pursuant to the terms of a securities lending agreement between the BMO ETF and any such borrower under which:
(i) the borrower will pay to the BMO ETF a negotiated securities lending fee and will make compensation payments
to the BMO ETF equal to any distributions received by the borrower on the securities borrowed; (ii) the securities
loans qualify as “securities lending arrangements”? for the purposes of the Tax Act; and (iii) the BMO ETF will
receive collateral security equal to at least 102% of the value of the portfolio securities loaned. If a securities lending
agent is appointed for a BMO ETF, such agent will be responsible for the ongoing administration of the securities
loans, including the obligation to mark-to-market the collateral on a daily basis.

This is very discouraging. Nothing is simple!

Christina,

For simplicity, you can replace ZFL (duration 13.9 / fees .2%) with: CA135087ZS68 3.5% 01.12.2045 (duration 20 approx /fees 0/no lending risk/longest CA gov bond available).

It is much safer and much superior for a CA PP, IMO.

8% of ZFL holdings is CA135087ZS68.

Arrghh...

Lending shares puts your money in others' hands

Fund managers make millions from lending clients' shares, study shows

Not only are the shares lent out, but they are typically used to short the shares — pushing the value of the funds down.

A bit tangential, but a reader of my blog wrote to iShares and asked about certain funds if they are direct holdings or derivatives. This was their response which I was given permission to re-post:

>Thank you for your interest in iShares.
>
> Further to your email, we have stipulated which of the funds you are holding are physical/synthetic below:
>
> TLT - Physical
> ACWI - Physical
> IWRD - Physical
> EEM - Physical
> IDVY - Physical
> IUKD - Physical
> JSC - Non iShares ETF - Statestreet -
> EWJ - Physical
> XMWO - Non iShares ETF - DBX Trackers - Synthetic ETF
> SHY - Physical
> SHV - Physical
>
> As of 19th September 2011, iShares managed 113 ETFs domiciled in Ireland of which only two were synthetic.
>
> Please note some of the products listed above are not Irish domiciled iShares ETFs.
>
> Should you require any further assistance please do not hesitate to contact us.
>
> Best regards,
>
> iShares Feedback
>

just to be clear, physical doesn't mean they're not lent out. To wit, see this correspondence:

my question:
Client Comment:
I am a shareholder of the 1-3 year US treasury bond fund, SHY. What is the current percentage of treasuries which are lent out? What is the maximum allowable percentage of treasuries which the administrators can lend out? Please point me to the most recent audited financial statement.


response:
Thanks for getting in touch with us about iShares ETFs. The most recent figures from the securities lending operation in the 1-3 year US Treasury Bond Fund can be found in the most recent annual report, on page 23, which I have included. Pursuant to the requirements of the investment company act of 1940, no more than one-third of the the value of the fund's total assets may be lent at any one time. If you have any other questions please contact us at            1-800-iShares      (            1-800-474-2737      ) Monday through Friday, 8:30 a.m. to 6:30 p.m. (EST) and we will be there to assist you.   



Sincerely,


BlackRock