Custody accounts produce returns that may be different from those of the securities held within them. This is because of their cash component, which generates no return (or, in case of leverage, amplifies the securities return).

Let’s look at some examples. 

  1. In the first scenario, I transfer 100 USD into a broker account on 1 January. On 10 January I buy 50 USD worth of stock X, and my broker charges me 1 USD for the transaction. The only other transaction that occurs in the year is a dividend of 3 USD on 15 April. On 31 December, my stock X is worth 53 USD, and I sell it.  The MWR of my Broker Account is 5%.
  2. In the second scenario, I buy 50 USD worth of stock X on 10 January, and my broker charges me 1 USD for the transaction. The only other transaction that occurs in the year is a dividend of 3 USD on 15 April. On 31 December, my stock X is worth 53 USD, and I sell it. The MWR of my share Investment is 10.5%.

How is this possible? The answer lies in the cash sitting idle in the broker account, in the first scenario. The return of my investment in stock X is “diluted down” by a zero return on cash. The 5% return is calculated on 100 USD, with only half actually invested. The 10.5% return is calculated on 50 USD .

There is a third scenario, slightly more complicated. 

  • I transfer 100 USD into a broker account on 1 January, but on 10 January I buy 150 USD worth of stock X as my broker agrees to lend me 50 USD. He charges me 1.5 USD to buy stock X and 3 USD upfront to lend me the money. The only other transaction that occurs in the year is a dividend of 9 USD on 15 April (the dividend is 3x as I bought 3 times as many shares). On 31 December, my stock X is worth 159 USD; I sell it and return 50 USD to the broker. The MWR of my broker account (as of 31 December) is 9%. 

This is the leverage effect: if the cost of borrowing money is lower than the return I can achieve investing the money I have borrowed, I can amplify the return on my investment. 

Leverage is a double-edged sword though, as I need to return 50 USD to the broker no matter what the value of stock X is on 31 December. Leverage amplifies returns in both directions, making my gains larger OR my losses greater, depending on the performance of the investment I have made with the money I borrowed.