Lending out your long positions

[BRK7]

I recently had a conversation with a broker about lending out long positions (for the brokers' stock loan book) as a way to generate some extra income.  I wondering if you folks have any experience in this area?

 

The broker said the split would be 70%/30%, with the 30% piece going to the broker.  Is this a typical split?

 

I'm wondering what the downside is? Any reasons to avoid doing so if managing a pooled investment vehicle (limited partnership)?

 

Thanks for any insights!

[Guest Schwab711]

As the lender, your primary risks are:

1) counterparty risk - only do this with IB, Fidelity, or other major brokers. You will no longer own your positions and have no SIPC protection! There is also no guarantee your stock will be returned (though, "failure to deliver" is usually rare).

2) taxes - your stock appreciation and manufactured dividends are taxed as normal income, which may be much greater than normal dividend or capital gains taxes. I think they have mandatory tax withholding on manufactured dividends.

3) no voting rights - don't own stock

 

30% is reasonable for good CP.

 

What are your plans with the collateral (where most income is made)?

 

Basically, higher and unnecessary taxes may be greater than earned income from lending. Usually the broker (agent) is the big winner in Sec Lending.

 

Overall, it's generally very low risk, very low return income, if collateral reinvested responsibly. Repos are likely preferrable, if possible.

[Hielko]

70/30 seems like a good split to me, I get 50/50 at IB.

 

And to minimize the tax impact your broker should recall your shares before the ex-div date. Counter-party risk is by the way very minimal since you get collateral.

[schin]

Can you talk more about the tax implications other than income from the borrower?Does it force you to keep those shares in short term status even if hold it longer than a year?

 

?

[wachtwoord]

70/30 seems like a good split to me, I get 50/50 at IB.

 

And to minimize the tax impact your broker should recall your shares before the ex-div date. Counter-party risk is by the way very minimal since you get collateral.

 

IB withholds the same taxes on dividends and on payments in lieu of dividends for me.

[TwoCitiesCapital]

Would you be able to do this within an IRA where taxes aren't part of the consideration?

[BRK7]

Thanks, for the great replies.

 

Schwab711, you sound like you have some experience in this field, and I appreciate your insights. 

 

The counterparty in my case would be Pershing (subsidiary of BNY Mellon) or possibly Goldman.  So, if feel like the counterparty risk is minimal.

 

However, the tax issues are potentially significant (both from an economic as well as a complexity standpoint), and it strikes me that the tax issues could easily bring more trouble than they are worth.  (Alternatively stated, an incremental hour of my time would likely be better spent looking for mispriced securities, vs. getting into a somewhat tangential and esoteric area of “investing” that offers very modest income potential.)

 

I can see where lending could be worthwhile in a special case where I had a large position in a hard-to-borrow security, and the economics of the lending were unusually attractive.

 

For anyone else interested in learning more, I found the following article to be helpful:

 

https://personal.vanguard.com/pdf/icrsl.pdf

 

TwoCities, good question about doing this in an IRA.  I don’t know if that is possible...my gut tells me that it would be very complicated having an IRA custodian involved and so forth.

 

[gg]

Any reasons to avoid doing so if managing a pooled investment vehicle (limited partnership)?

 

 

I think it's definitely worth considering if you are happy to be long a hard-to-borrow security.

 

Just thinking out loud, but if you are managing other people's money, one consideration is that if you are wrong, and the short thesis turns out to be correct, you may appear additionally foolish to your investors. Say you are long TSLA shares today, and you tell your investors that one of the reasons you are long is because there's a huge opportunity to lend out the shares and get double-digit returns on that investment solely from the securities lending...if TSLA plunges because the short-thesis gets validated by the market, then your investors might be more unhappy than if you had been involved in a security with fewer shorts involved.

[AccentricInv]

Any reasons to avoid doing so if managing a pooled investment vehicle (limited partnership)?

 

 

I think it's definitely worth considering if you are happy to be long a hard-to-borrow security.

 

Just thinking out loud, but if you are managing other people's money, one consideration is that if you are wrong, and the short thesis turns out to be correct, you may appear additionally foolish to your investors. Say you are long TSLA shares today, and you tell your investors that one of the reasons you are long is because there's a huge opportunity to lend out the shares and get double-digit returns on that investment solely from the securities lending...if TSLA plunges because the short-thesis gets validated by the market, then your investors might be more unhappy than if you had been involved in a security with fewer shorts involved.

 

Wow.  Had no idea TSLA had such a high borrow, until you pointed it out.  IBKR's indicating a 30.2% rate right now.  Now I'm just imaging all those retail investors long TSLA, who don't know about lending out there shares.  What a shame.