Industry Updates

Charlie Munger blasts index funds and the ‘emperors’ behind them

The rise of common ownership is creating a new centre of power for corporate governance

Jamie Gordon

Charlie Munger

Renowned investor and Berkshire Hathaway vice president Charlie Munger has joined the chorus warning against the growing power of index funds and the large stakes they control in the majority of companies across the US.

Speaking at the annual meeting of Daily Journal Corp, a publishing company he has chaired for almost five decades, Warren Buffett's business partner cautioned: “We have a new bunch of emperors, and they are the people who vote the shares in the index funds.”

Munger (pictured) then turned his sights on BlackRock, the world’s largest asset manager, which recently surpassed $10trn assets under management (AUM), largely driven by its championing of passive products.

On BlackRock’s founder, chairman and CEO Larry Fink, Munger continued: “I think the world of Fink, but I am not sure I want him to be my emperor.”

Munger’s words come after accusations BlackRock along with Vanguard and State Street Global Advisors (SSGA) – the ‘Big Three’ – have increasingly used their votes as a marketing tool to appeal to millennial investors on issues such as environmental stewardship and gender representation on company boards.

In fact, in his paper titledOpportunism in the Shareholder Voting and Engagement of the ‘Big Three’ Investment Advisors to Index Funds, Bernard Sharfman, senior corporate governance fellow at the RealClearFoundation, argued this “millennial strategy” means “portfolio primacy is sacrificed for the economic good of the investment adviser”.

Responding to such concerns in his annual letter to company CEOs, BlackRock’s Fink categorically stated his firm’s approach to shareholder capitalism is not “woke”.

Instead, he argued asset managers have a fiduciary duty to bring private capital on the journey to net-zero or risk “the biggest capital arbitrage of our lifetime”. However, as part of this, he opposes blanket divestment from fossil fuel companies, stating “foresighted companies across a wide range of carbon-intensive sectors are transforming their businesses”.

Overall though, many are aware the power of index funds and the growing stake they hold in companies’ decision-making processes goes beyond a ‘woke’ versus non-woke issue.

In 1980, common ownership of US companies by asset managers stood at 10%. By 2017 this stood at 80%. The ‘Big Three’ alone comprised 5% of ownership of all US-listed, large companies in 1998, up to around 20% in 2019, with the potential for this to grow to 33% within the next decade, according to Harvard Law School’s Lucian Bebchuk and Boston University’s Scott Hirst.

As Robin Wigglesworth, author ofTrillions: How a Band of Wall Street Renegades Invented the Index Fund and Changed Finance Forever, toldETF Stream:“The scale nature of the index industry means the big will naturally get bigger and barring any unforeseen regulatory intervention, BlackRock and Vanguard are going to become even more titanic than they are today.

“At some point, they will control the majority of votes of every major company in the US and globally. This will be one of the defining battlegrounds for index funds and ETFs in the coming decade given the trend shaping the market today.”

In response to growing concerns, BlackRock took the step of introducing direct voting for asset owners in 40% of its $4.8trn in equity index funds last year, with the view of extending this to individual investors at a later date through a form of pass-through voting.

Nate Geraci, president of The ETF Store, agreed with Munger’s underlying warning but took to Twitter to state he believes technological solutions will in time play a key role in allowing investors at different scales to voice their preferences on different issues.

For the time being, Ben Johnson, director of global ETFs and passive strategies research at Morningstar, cautioned BlackRock are in a fairly unique position of being able to offer direct voting rights, owing to the sheer scale of their institutional client segment.

We may have to wait some time until other asset managers follow suit with direct voting rights for institutional clients – and longer still for such rights to be extended to the retail armies that make up titans such as Vanguard.

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