Index fund managers and Congress know that the U.S. mutual fund industry is broken: instead of focusing on return on investment, fund managers use the power of funds to promote political priorities. Solutions for this broken industry are within reach and index fund investors should consider the benefits of the different solutions on offer.
To understand how things got to this point, go back to the 1990s. Investors in index funds, from individuals to state pension plans, made an implicit agreement with fund managers such as the Vanguard Group: provide a diversified portfolio that offers market returns, low risk and low cost, and vote our actions as a prudent investor.
Index fund managers did just that, buying stocks from thousands of companies without the need for costly analysis by stock collectors, and relying heavily on company boards for recommendations on how to vote for stocks. .
In recent years, however, fund managers have moved away from this original business. They still buy basically all the stock and skip the search costs. But they are increasingly at odds with the board’s recommendations in favor of voting in politics, on thorny issues, from diversity in corporate procurement to carbon emissions and burdens from abortion to abortion. weapons.
While fund managers present these votes as tied to the end result, skeptical customers see that parish preferences work. This mix of finance and politics is one of the reasons why individual investors turn to alternative investment platforms and why several states have withdrawn their pension savings from the managers of more serious index funds.
Some index funds are receiving the message. The largest is BlackRock BLK,
whose CEO, Laurence Fink, has denied his reputation as an advocate of using the fund’s power to support progressive causes. BlackRock recently announced a plan to let its investors have their say if they so wish.
However, the BlackRock plan starts only with the largest clients in the fund and could take years to reach individual investors. In addition, the administration of this transmission vote will increase the costs of the fund. These costs could be offset by the benefits of voting focused on prudent investment, rather than being mixed with political causes.
But will index fund investors vote and will their votes be prudent? To the extent that index fund managers now put politics above the economy, the transmission vote will improve the status quo. On the other hand, many investors choose index funds to avoid research. If they don’t want to be bothered, they are unlikely to cast informed votes.
A better approach appears in a new U.S. Senate bill. Last week, Sen. Dan Sullivan (R. Alaska) introduced the Investor Democracy is Expected Act (INDEX) to help restore the original implicit business. Under the law, index funds with large holdings, mainly the three largest, BlackRock, State Street and Vanguard, could not vote their preferences on disputed issues, but could only vote the preferences of their clients, investors.
The law offers several advantages. First, the costs of the fund would fall because there is no requirement that votes be passed; it is simply an option. Second, index fund managers would not need the staff they currently pay to evaluate shareholder proposals that raise policy issues. Third, individual fund investors are not expected to vote, only indexers will not. As a result, the majority of votes would be decided by the collectors of institutional shares, the “smart money” who do their homework and focus on financial returns.
The INDEX Act and the BlackRock Plan validate other solutions that investors should consider. On the one hand, companies can play a role. The most common way index fund managers vote their political views is by shareholder proposals made by social activists, such as the As You Sow Foundation or The Sisters of St. Louis. Francis. These votes are not binding on companies, whose advice must interpret their meaning. Boards of directors could be better informed if they held a separate vote by shareholders of their non-index funds. Even if index fund managers voted for their policy, boards would have a separate vote to trust.
For an industry-wide solution, mutual funds that remain stock collectors can help. If they announce how they intend to vote on shareholders’ proposals, indexers may find that in decision-making and customers could easily compare how their votes are cast with “smart money”. A voting visibility database, such as the one I developed with a trading partner, is an easy way for index funds to track the voting positions of active funds.
The index fund industry allows millions of investors to get low-risk market returns at a low cost. But the bargaining investors who signed up did not imagine that fund managers would use their power to express political preferences. To preserve the business, the voting power of these managers must be removed. Fortunately, industry and Congress are paving the way for innovative solutions to protect investors and perhaps save the industry from itself.
Lawrence A. Cunningham is a professor at George Washington University, founder of the Quality Shareholders Group, and editor since 1997 of “The Essays of Warren Buffett: Lessons for Corporate America.” For updates on Cunningham’s research on quality shareholders, sign up here.
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