Latest / The High Net Worth Podcast with Fexingo: Wealth Management, Tax Strategy, and Affluent Finance / How Ultra-Wealthy Families Use Share Lending for Extra Yield
Transcript
- Lucas: Most wealthy families think about their stock portfolio as a buy and hold asset. You buy Apple, you hold Apple, you collect the dividend, you wait for it to go up. But what if that same stock could earn you an extra half a percent to two percent a year, just by sitting there? Luna: That sounds like securities lending. I've heard the term, but I don't think most people realize how common it is among ultra-high-net-worth families. Lucas: Exactly. Securities lending is basically this: you loan out shares you already own to a short seller who needs them to execute a bet that the price will fall. In return, you get a fee — a daily rate paid by the borrower. And you keep all the dividends and capital appreciation. The shares are still yours. Luna: But there's a catch, right? Otherwise everyone would do it. Lucas: There are a few catches, but let's start with the mechanics. The borrower posts cash collateral — usually 102 to 105 percent of the value of the loaned shares. That cash gets reinvested in short-term money market instruments, and the lender and the custodian split the interest earned. That's where the yield comes from, mostly. Luna: So the lender isn't getting paid directly by the short seller. They're earning interest on the cash collateral that the short seller posted. Lucas: Right. And the fee — the 'rebate' they pay to the borrower — depends on how hard that stock is to borrow. For easy to borrow stocks like Apple or Microsoft, the rebate is low, so the lender keeps most of the interest. For hard to borrow stocks — think small caps or heavily shorted names — the borrower pays a premium, and the lender can earn two percent or more annualized. Luna: I've seen family offices allocate five to ten percent of their equity portfolio to securities lending programs. It's not a huge number, but it's nearly risk-free income. Lucas: Nearly risk-free. The main risk is counterparty default — if the borrower goes under and the collateral isn't enough to cover the value of the shares. But custodians mitigate that by over-collateralizing and by marking to market daily. If the stock price shoots up, the borrower has to post more collateral. Luna: There's also the risk that the lender needs to sell the shares and can't because they're out on loan. But most programs let you recall the shares at any time. Lucas: Right. You can terminate the loan in one to three business days. So liquidity is rarely an issue. The bigger hidden risk is tax-related. If you lend out a stock that pays a dividend, you might receive a 'payment in lieu of dividend' instead of a qualified dividend, which gets taxed as ordinary income — not at the lower capital gains rate. Luna: That can really eat into the yield, especially for high-income families in top tax brackets. A qualified dividend might be taxed at twenty percent, but a payment in lieu can be taxed at thirty-seven percent plus the net investment income tax. Lucas: Exactly. So a well-advised family will either avoid lending around ex-dividend dates or use a program that provides a manufactured dividend to preserve the tax treatment. Some custodians do that automatically, but not all. Luna: Let's talk about who actually does this. Is it mostly family offices, or do ultra-high-net-worth individuals go through their private banks? Lucas: Both. The big custodians — JPMorgan, Goldman Sachs, UBS, Northern Trust — all offer securities lending as a standard feature for their wealth management clients. It's usually opt-in, and the custodian takes a cut. Typically the lender gets seventy to eighty percent of the revenue, the custodian keeps the rest. Luna: So if you have a hundred million dollar equity portfolio, you might earn an extra five hundred thousand to two million dollars a year just by signing a form. Lucas: That's the potential. But the actual return depends on the composition of the portfolio. A concentrated portfolio of large-cap blue chips will generate lower yields than a diversified portfolio that includes some mid-caps or ETFs that are in high demand by short sellers. Luna: I've actually seen some families use securities lending as a way to generate income during low-yield environments, when bonds aren't paying much. It's a nice diversifier. Lucas: And let's not forget that securities lending isn't just for stocks. You can lend bonds, ETFs, even mutual funds. Bond lending is actually a huge market — pension funds and insurance companies lend their fixed-income holdings to generate extra yield. Luna: But there's also a regulatory layer now. The SEC's Rule 10c-1, which went into effect in 2024, requires that securities lending transactions be reported to a registered clearing agency within 15 minutes. That increased transparency has actually reduced some of the spreads, but it's also made the market more efficient. Lucas: Great point. The rule was designed to shed light on short selling after the GameStop frenzy. But for lenders, it means more competition and potentially lower fees. Still, for a passive income stream, it's hard to beat. Luna: I want to come back to the tax issue, because I think it's the biggest tripwire. Let's say a family office lends out five million dollars' worth of a stock that pays a three percent dividend. If they don't manage the ex-dividend dates, they could lose half the benefit to higher taxes. Lucas: Absolutely. That's where a good advisor earns their fee. Some families simply exclude from the lending program any stocks that pay dividends. Others use a 'dividend capture' overlay — they recall the shares before the ex-dividend date and re-lend them after. It's a bit of work, but the software handles it. Luna: And there's also the question of voting rights. When you lend shares, the borrower gets the voting rights. So during proxy season, families might pull back shares to vote on important issues. Lucas: Right. Most family offices are long-term holders, so they care about governance. They'll recall shares for shareholder meetings on things like board elections or M&A votes. That's easy to do, but it does reduce the lending income for those periods. Luna: Let me ask you this: how does securities lending compare to other yield-enhancing strategies like covered calls or direct indexing? Lucas: Covered calls generate income but cap upside — if the stock skyrockets, you miss out. Direct indexing gives tax-loss harvesting but requires a separately managed account. Securities lending is completely passive and doesn't cap gains or trigger taxable events unless you mess up the dividend treatment. It's probably the simplest yield enhancement for a long-only portfolio. Luna: It's also one of the oldest. I mean, institutions have been doing this for decades. But it's only recently become more accessible to individual wealthy families, thanks to better technology and lower minimums. Lucas: That's true. Some custodians now allow lending on portfolios as small as one million dollars. And with automated recall and tax optimization, the friction is much lower than it used to be. Luna: If today's episode was actually useful to you — if it gave you a concrete idea to discuss with your advisor — the way we keep this podcast ad-free is through listener support. You can find us at buy me a coffee dot com slash fexingo. Lucas: Yeah, it's a small gesture that lets us keep digging into these niche strategies without any sponsor pressure. We really appreciate it. Luna: So back to securities lending — one thing I want to highlight is that not all custodians are created equal. JPMorgan's program, for example, is very automated and offers a 50-50 revenue split on some accounts. Goldman tends to be more bespoke but charges higher fees. Lucas: And the reinvestment of cash collateral matters too. Some custodians sweep it into a money market fund that yields four percent, others into a lower-yielding account. That difference can dramatically affect the net return to the lender. Luna: So what's the takeaway for a family with a hundred million dollar equity portfolio? Should they automatically enroll in securities lending? Lucas: I'd say they should seriously consider it, but only after a thorough review of tax implications and the specific terms of their custodian's program. For most families, the incremental yield — even one percent — is significant when multiplied by a nine-figure portfolio. And the risk is minimal if managed properly. Luna: It's one of those strategies that sounds too good to be true but actually works — as long as you pay attention to the details. Lucas: Exactly. Securities lending won't make you a fortune on its own, but as a portfolio enhancement, it's a smart, underutilized tool in the wealth management toolkit.