Index fund investing has taken over the world. In December, US investors for the first time entrusted more money to index funds than to actively managed funds, where a manager selects stocks or bonds for you.
There is a good reason for the popularity of index funds. For most people, it was more profitable to own a small portion of the entire market, which can be done at low cost with an index fund, than to buy and sell securities, either alone or through a manager.
But the unstoppable growth of index funds comes at a price. A key problem is that the most diversified funds own shares in every publicly traded company on the market, and if you don’t like a company or its specific policies, you’re screwed. You couldn’t even vote on issues you thought were important because, until recently, fund managers insisted on doing it for you.
Well, that has changed a lot.
BlackRock said this month that it is expanding an experimental program to offer investors six policy choices when voting on company issues – such as a focus on climate change or a preference for religious values. State Street already has a similar program underway, and Vanguard is also moving into this type of voting.
Collectively, the three giant fund companies have given tens of millions of investors with $4.6 trillion in assets the opportunity to express their views on corporate issues. This is certainly an improvement. And it could ultimately lead to sweeping changes across corporate America, even as it alleviates some thorny problems for the big index fund companies.
The problems
According to scholars like John Coates, author of “The Problem of 12: When a Few Financial Institutions Control Everything,” the growth of index funds has had the unintended consequence of weakening shareholder democracy.
A handful of index fund companies, led by BlackRock, Vanguard and State Street, have become universal owners, Mr. Coates, a Harvard law professor and former Securities and Exchange Commission official, said in an interview.
“Index funds have too much power,” he said. “They are the largest shareholders in almost every publicly traded company. And the trend towards over-concentration of ownership continues.”
Until recently, index fund managers — rather than the millions of people who invest in their funds — had full power to give voting rights or voting rights to fund shareholders. These voting rights potentially gave fund managers a decisive voice on crucial issues, such as the level of a company’s CEO’s salary or whether the company was environmentally responsible or whether it treated its employees properly.
Three years ago, for example, BlackRock, State Street and Vanguard cast the deciding votes in a proxy fight at fossil fuel giant Exxon Mobil and helped elect three dissident members to its board with the goal of forcing the energy giant to cut its carbon emissions. Reduce footprint.
But the fund companies have become uncomfortable in the public spotlight. They are caught up in the culture wars – criticized by the left for not giving sufficient consideration to environmental concerns and by the right for over-emphasizing them. State Street and BlackRock and other financial firms have recently backed away from broad commitments to combat climate change, saying they need to focus even more on their purely financial functions.
With this in mind, it is not entirely shocking that fund companies are beginning to give fund shareholders a significant degree of voting power – and effectively share responsibility for difficult decisions with retail investors and institutional investors such as pension funds.
Whatever the fund companies’ motives, the changes in voting decisions could alter the distribution of power in the corporate universe.
Choice
What the companies are experimenting with is not true “pass-through voting,” in which millions of fund shareholders are asked how they want to vote in thousands of voting exercises each year, and those individual votes are then actually cast accordingly.
Instead, the companies offer investors something simpler and more manageable: broad policy decisions.
BlackRock, for example, announced on February 13 that it was offering three million retail investors a “pilot” choice of a simple, popular S&P 500 index fund, the iShares Core S&P 500 ETF. (That’s short for Exchange Traded Fund, an index fund that can be traded all day on the stock exchange.) Many pension funds and other institutions that invest with BlackRock can already exercise their voting rights at will.
At BlackRock, $2.6 trillion, or half of the company’s stock index assets, are eligible for so-called voting choice. “Customers with $598 billion in total assets have been using Voting Choice since December 29, 2023,” the company said in an email. It added: “This represents approximately 25 percent of total eligible assets.”
State Street has already created $1.9 trillion in assets – more than 80 percent of its total stock index assets – that are eligible for inclusion in its proxy choice program. This includes a wide range of popular ETFs, although not the largest S&P 500 ETF, known as SPY.
Fund assets worth about $250 million held by individuals and about 10 percent of institutional assets are voted under six different guidelines, Lori Heinel, chief investment officer at State Street Global Advisors, said in an interview. “We don’t see what we do as an experiment. We are on the market. It’s available.”
Vanguard, which launched the first commercially available index fund, is taking a slower approach. Six of its funds, with $100 billion in assets, are part of what the firm calls an experiment. These are the index funds S&P 500 Growth, Vanguard Russell 1000, ESG US Stock ETF, Mega Cap and Vanguard Dividend Appreciation. This is just a start, the company said in an email.
“We are using our pilot to gather customer feedback, refine our approach and optimize the investor experience as we expand to additional funds,” Vanguard said. It says it offers four choices, but two are more like non-choices: don’t vote at all or let Vanguard vote for you.
How it works
What this all means in practice is that if you are an eligible shareholder, you can still have a fund company make voting decisions for you (or, in the case of Vanguard, withhold your vote). But you now have other options.
If you wish, your votes will be cast based on recommendations from a shareholder advisory service that follows a specific policy.
These are the options at BlackRock. Three are advised by Institutional Shareholder Services:
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Socially Responsible Investment (SRI) Policy. It is expressly aimed at investors who demand that companies behave in a “socially and environmentally responsible manner”.
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Catholic faith-based politics. In general, “socially and environmentally compatible” behavior is also required. But last year, according to BlackRock, this policy rejected an unsuccessful proposal at Coca-Cola that required the company to report on how state abortion restrictions could affect its business.
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Global policy aligned with the board. This is what most corporate boards would prefer, with votes “generally consistent with the board’s recommendations on “environmental and social issues.”
Three guidelines come from Glass Lewis:
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Benchmark policy. It includes classic good governance principles. Many proxy votes are not binding, but with this policy, boards should act as if they are binding and be responsive to shareholders’ wishes.
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Climate policy. It holds boards to strict environmental standards. The policy also takes gender diversity into account: “If less than 30 percent of the board is female, the climate policy will vote against all incumbent male nominating committee members for large and medium-sized companies.”
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Policy focused on corporate governance. It emphasizes “the fiduciary responsibility to enhance long-term economic shareholder value.”
How these guidelines affect practical coordination is not always the case clear. On many issues they will certainly lead to different results. A case in point is a ballot measure last year that required Exxon Mobil to report on how workers and communities affected by plant closures will be affected by the transition away from fossil fuels.
In an email, BlackRock said Exxon management, BlackRock policymakers and the Board Aligned Policy all opposed the decision. But the Catholic Faith-Based Policy, the Socially Responsible Investment Policy and the Glass Lewis Benchmark Policy all supported this.
Unlike the proxy battle at Exxon in 2021, this one failed. BlackRock is Exxon’s third-largest shareholder, according to FactSet. The only companies with larger shares are Vanguard and State Street.
This splintering of the immense BlackRock vote may be what Larry Fink, the asset manager’s founder and CEO, intended when he said in a letter to the company’s shareholders last year: “There are many people who have an opinion about how we should manage our customers’ money. But the money doesn’t belong to these people. It’s not ours either. It belongs to our customers and our responsibility and duty is to them.”
State Street’s policy decisions are similar to those of BlackRock. Vanguard’s two program options include a “board-focused policy” and an ESG or climate policy.
looking ahead
An important question is how voting programs will impact voting in this corporate voting season that is just beginning. Lindsey Stewart, director of investment stewardship research at Morningstar, closely monitors fund companies’ voting patterns. He says he can’t say if they made much of a difference last year.
Professor Coates says current election manifestos are complex and may not attract much interest unless businesses find ways to focus on the most pressing issues each year. He cited ongoing battles over labor issues at Starbucks, major climate issues at fossil fuel companies or disputes over reproductive rights as areas that fund companies could highlight. Translating voting guidelines into actual votes is important, he said, and must be done clearly before proxy voting.
“I see this as progress, but it is far from perfect,” Professor Coates said.
Now at least the fund shareholders condemned to silence have better prospects of finally having a voice.
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2024-02-23 19:04:56
www.nytimes.com
