Although there’s no rule against it, the barrier seems to be that few fund holders are aware of the option, the report noted. This points to a largely unexplored source of revenue for ETF buyers.

“Many ETF investors are focused on long-only, buy-and-hold strategies, and they just haven’t looked into this option,” said Sebastian Mercado, ETF strategist at Deutsche Bank AG. “If they’re comfortable with the operational and counterparty risk, then it could be an attractive opportunity to increase returns.”

Awareness Problem

ETFs that have generated the most fees from securities lending over the last 12 months include heavily-traded S&P 500 funds, funds that track hard-to-short asset classes like high-yield bonds and emerging market equities, and those that hold volatile securities like small cap stocks and biotechnology shares.

Each of the 10 most profitable ETFs to lend, which account for a third of the total revenue from borrowing, have assets under management of more than $1 billion, and six are bigger than $10 billion. In general, smaller funds don’t have enough liquidity to attract short sellers or investors willing to lend them out.

“There’s a handful of the ETFs that tend to be a focus for shorting and most investors are using them in a long only manner,” said Todd Rosenbluth, director of ETFs and mutual funds at CFRA Research, an independent research provider.

In many cases investors holding liquid ETFs miss out on the chance to earn extra revenue simply because they’re not aware of the option, Mercado said. For example, the $55 billion PowerShares ETF QQQ Trust Series 1 ETF, which tracks the Nasdaq 100 Index and goes by the symbol QQQ, and Vanguard’s $31 billion Value ETF, ticker VTV, have 2 percent or fewer of their shares in lending programs, compared with an average of 5 percent for ETFs with more than $30 billion, according to IHSMarkit.
Borrowing Fees

About 6 percent of the 2,200 ETFs with lending programs in the U.S. have offset or earned more for their investors in securities lending programs than the costs incurred by management fees over the last 12 months, the IHSMarkit report stated. The most profitable was the iShares iBoxx $ High Yield Corporate Bond ETF, known as HYG, where investors made a total of $21 million from lending shares in the past year, the report showed.

Over the last 12 months, ETF investors have earned more than $167 million from lending shares in the funds they hold, according to the report. On average, U.S. ETFs charge 55 basis points to borrowers, compared with 46 basis points in U.S. equities, though that figure includes rates for ETFs holding everything from bonds to commodities, not just stocks.

In this way, higher borrowing costs may be more profitable for investors than lower fees. For example, HYG has an expense ratio of 50 basis points, higher than the 40 basis points charged by rival SPDR Bloomberg Barclays High Yield Bond ETF, ticker JNK. But HYG investors pocket 268 basis points when they lend the shares, compared with just 96 basis points for JNK holders.