Equity Lending and Mutual Fund Performance

Abstract

A mutual fund board’s decision to approve an equity lending program entails an important trade-off. While equity lending can generate additional income for shareholders, it also enables the short-selling of stocks owned by the fund, which could negatively impact stock prices and fund performance. We empirically examine this trade-off using a sample of U.S. active and passive equity mutual funds. From 1996 to 2009, the percentage of funds that lend equities quadruples, from 13% to over 40%. We examine the determinants of the decision to lend out shares, the percentage of the overall portfolio being lend out and the income generated by security lending. Looking at performance we find that active funds that engage in share lending under perform other funds. Our findings suggest that short sellers have an information advantage over mutual funds and that mutual funds are restricted in acting on the information signal of short sellers.