Fund managers promise to invest your money with a view to delivering good returns. But what happens to your cash once it’s invested? You may assume your assets sit protected in their safe. The truth is quite different.
If you invest money with a fund manager, at first you’d expect them to buy some investments on your behalf. And then, when you want your money back, you’d expect them to sell off the shares and return your cash. But it’s not that simple, far from it.
Managers frequently lend out the shares they’ve bought with your money to make a bit of extra profit. In fact, many of them are willing to lend out 100% of the assets they own at any one time. This process is known as stock lending.
The trouble is, despite your assets being put at risk, fund managers often help themselves to a big slice of the profits. Some take a 40% cut, while many others give a large percentage to an agent that carries out the lending on their behalf. All of which is cutting into your slice of the pie.
Fund managers’ cut from stock lending
When we looked at 10 of the UK’s largest fund managers, we found that you’d only get around 60% of the revenue back from BlackRock, SWIP, Schroders and Liontrust.
Why are they giving so little back? Well, BlackRock told us that it has to invest heavily in risk management to ensure that its stock lending is carried out responsibly.
I won’t go into too much detail about what happens to your shares when they’re lent out, but it goes something like this: you give your money to a fund manager, who shares your money with another manager, who then sells your shares and buys them back at a later date in the hope of making a profit. If you’re still a bit lost, this diagram might illuminate things:
You’re affected if you have a pension
If you’ve got a pension you could be affected too. Pension funds, which tend to invest in stocks and shares via lots of different fund managers, lend out huge amounts of stock. One standard work-based scheme we looked at had £3.6bn of assets on behalf of its policy holders, £1bn of which was lent out in March this year.
So exactly where your assets are right now, is anyone’s guess.
Fund managers don’t lend out your money for nothing of course. They receive a fee for lending and also get something in exchange for the period of the loan. This ‘collateral’ could be cash, other stocks and shares or bonds, and it will typically be worth more than the value of what they’ve lent out.
A worthwhile risk?
But there’s still the risk that the company that’s borrowed your shares could go bust and won’t be able to repay the money.
Although the process of stock lending is accepted by global financial regulators, as it can help keep markets moving, surely the profits should go back into the fund so you and me benefit from any additional risk? Especially as we pay annual charges regardless of investment performance so the manager never goes without.
Personally I’d like to see more retail investment funds keeping things simple and avoiding extra risk. And if they must engage in stock lending, they should ensure that risk is kept to an absolute minimum and their customers must see all the profits.