The ‘Big Three’ of BlackRock, Vanguard and State Street Global Advisors (SSGA) are largely uninformed about the companies their index funds hold, so either vote with management or “opportunistically” to increase their market share, according to academic research.
The paper, titled Opportunism in the Shareholder Voting and Engagement of the ‘Big Three’ Investment Advisers to Index Funds, argues large asset managers either defer to board recommendations or implement a “millennial marketing strategy” when engaging to appease activist shareholders and minimise regulatory risk.
Author Bernard Sharfman of the RealClearFoundation noted it is difficult for the largest index fund issuers, whose products house trillions of dollars of assets from tens of millions of clients, to represent the disparate interests of each end investor.
He added in an industry with “extremely low management fees”, the ‘Big Three’ are unable to expand the stewardship function for the thousands of securities their products hold and as such, they act as uniformed voters.
“The ‘Big Three’ are not being paid to be informed, only to do as much as they can to serve the interests of beneficial investors when they vote and engage on their behalf,” Sharfman said.
Without being informed, he argued the only way for asset managers to protect “portfolio primacy” is to implement a policy of deferring to board voting recommendations – a behaviour the ‘Big Three’ are known to carry out, as documented in papers by As You Sow and the National Bureau of Economic Research.
However, Sharfman said there are instances where large issuers cast votes “opportunistically”, where the outcome being supported would not enhance returns on company stock.
“Since the ‘Big Three’ are generally uninformed, they cannot enhance the value of the stock market through their uninformed voting and engagement,” he continued. “Instead, they focus on enhancing market share. This is where they get the most ‘bang for the buck’.
“The successful implementation of a marketing strategy, as reflected in an increased market share of a US stock market currently valued at around $50trn, provides an opportunity for the ‘Big Three’ to potentially acquire trillions of dollars of assets under management (AUM) without having to become informed.”
One way asset managers do this is by appealing to large groups of future or long-term clients, such as millennial investors, where the value of portfolio stocks becomes a secondary concern to increasing issuer market share.
Although taking a more pessimistic tone, these findings chime with those from a recent NBER paper titled Corporate Governance Implications of the Growth of Indexing, which said large index fund issuers have similar incentives to engage as active managers.
In fact, a 1% increase in the value of typical ‘Big Three’ positions in a company increases their annual management fees by an average of $133,000, the paper said.
Given these engagement activities are normally in pursuit of non-fiduciary causes, Sharfman warned they “can only lead to wealth reduction for investors”.
While noting the importance of asset managers carrying out their fiduciary duty, he concluded by supporting initiatives to allow investors to express voting preferences such as voting with the asset manager’s recommendations, voting with company management or abstaining altogether.