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Why do you say that index funds are supposed to be low risk? That's not really true; they in fact desire to have precisely the risk profile of whatever benchmark they target and seek minimal tracking error relative to that.

Anyway, loans are marked to market daily with collateral required. Details are here: https://personal.vanguard.com/pdf/ISGSL.pdf

It is absolutely a risk, but I think you err by saying index funds are supposed to be low risk.

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Obviously I am talking about the risk inherent to the fund separate from the risk of what it's tracking, which is arbitrary. The inherent risk of the fund is absolutely supposed to be low.

Thanks for the link, but I think even with 102% collateral marked to market daily, short sellers could still default and cause the fund to lose gains. It would be a black swan event, but the losses would be much larger than the 3 basis points they claim to gain from lending. Missing a small number of up days in the market has a huge negative effect on returns.

I see what you mean. The only thing I would add is that they do credit analysis on who they are lending to, and it's basically just institutional investors not fly-by-night short-sellers.

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