Are BlackRock and Vanguard Too Big and Powerful?
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Welcome to Money for the Rest of Us. This is a personal finance show on money, how it works, how to invest it, and how to live without worrying about it. I'm your host, David Stein. Today is episode 390. It's titled, Are BlackRock and Vanguard Too Big and Powerful?

I recently received an email from a longtime listener. She is in her 80s. She mentioned that her individual retirement account, all of her grandchildren's college 529 plans, and most of the rest of her net worth is managed by Vanguard. She finds Vanguard easy to work with. They've provided helpful tax management strategies.

But she sent me an article that concerned her. It was an editorial in the New York Times by Farhad Manjoo. It was titled, What BlackRock, Vanguard, and State Street are Doing to the Economy. Manjoo suggests these three asset management firms control too much of the economy.

How can that be? Aren't they just investing in stocks on behalf of their clients, most of which are in index funds? Yes, of course. But the amount that they manage in assets keeps growing. The most recent ICI fact book had an interesting chart. It showed in 2005, the five largest fund complexes, which would include Vanguard and BlackRock, controlled 35% of total assets.

assets in mutual funds and ETFs. By 2021, or year-end 2021, it was 54%. The top 10 now control 66% of assets and the top 25, 83% of assets.

The two largest by far are BlackRock with $9.6 trillion in assets under management, followed by Vanguard with $8.1 trillion in assets under management. BlackRock recently wrote in an investment stewardship update that the assets we manage are owned by other people, our clients, who depend on BlackRock to help them achieve their investment goals.

These clients include public and private pension plans, governments, insurance companies, endowments, universities, charities, and ultimately individual investors, among others. Our voting on clients' behalf were so authorized by them and will always be undertaken with the appropriate consideration of our clients' long-term economic interests as their fiduciary.

A fiduciary is a relationship in which an individual has placed trust and confidence in another person or entity, who in turn accepts that trust and seeks to act in the individual's best interest. Vanguard, BlackRock, and other asset managers are fiduciaries, and they do vote shares in shareholder votes for the companies that they own on behalf of some of their clients.

As an investment advisor, we assisted our clients in hiring asset managers to manage separately managed accounts. Those accounts were custodied at banks and the asset manager had authority to trade the shares. The client owned the shares, the underlying stock shares. Those clients would often designate the asset manager to vote on shareholder proposals, including votes for who should be on the corporate board's

of the individual companies. These were proxy votes.

That's different as individual investors holding shares in a Vanguard Index Mutual Fund, or ETF, or a BlackRock iShares ETF. In that case, we are shareholders in the ETF or index fund, the investment vehicle. We don't have ownership rights in the underlying securities those funds invest in. Those ownership rights belong to Vanguard or BlackRock.

John C. Coates, professor at Harvard Law School, wrote, the individual investors in Vanguard were active in choosing Vanguard and whether to retain it and have rights as shareholders of Vanguard's fund. But the Vanguard investors have no rights as shareholders of Apple, and the only thing they can effectively do with their Vanguard fund rights is to sell or redeem their shares, which in

entails not only selling the interest in Apple shares, but also all the shares of the other 499 companies in the S&P 500. It is Vanguard's employees who exercise the rights associated with shares of Apple. If you go through and Google top shareholders for any stock that trades in the U.S., invariably you'll find Vanguard and BlackRock among the top shareholders.

In the case of Apple, Vanguard owns 7.4% of all outstanding shares of Apple. BlackRock owns 4.2%. Target Corp. Vanguard owns 9% of Target. And BlackRock owns just about 6% of shares. Even smaller companies, somewhat controversial companies. Sturm Ruger & Company is one of the nation's leading manufacturers of firearms. They make guns.

BlackRock owns 16% of Sturm Ruger and Vanguard owns 15%. Combined, Vanguard and BlackRock control 30% of the shares of one of the largest gun manufacturers in the U.S.

One of BlackRock's former clients is the state of West Virginia. The state recently fired BlackRock because it felt the firm wasn't acting in its best interest. Now, it was just a small account, only a million dollars. West Virginia State Treasurer Riley Moore said in a statement, the decision was based on recent reports that BlackRock has urged companies to embrace net zero investment strategies that would harm the

the coal, oil, and natural gas industries, while increasing investments in Chinese companies that subvert national interest and damage West Virginia's manufacturing base and job market.

Later, Moore said, we're an energy state, and energy accounts for hundreds of millions of dollars of tax revenues for us. All our jobs come from coal and gas. I mean, this is who we are. This is part of our way of life here in the state. And they're telling us these industries are bad? We have an existential threat here. We have to fight back.

BlackRock, in their stewardship report, says, we believe that climate risk is investment risk, and we're seeing growing recognition that climate risk and the energy transition are already transforming both the real economy and how people invest in it. BlackRock CEO Larry Fink, in his 2022 annual letter to CEOs, wrote, stakeholder capitalism is not about politics. It's

It's not a social or ideological agenda. It's not woke. It is capitalism, driven by mutually beneficial relationships between you and the employees, customers, suppliers, and communities your company relies on to prosper. State Treasurer Riley Moore of West Virginia doesn't agree with that. He disagrees with the stance BlackRock has taken regarding climate change.

The concern with BlackRock and Vanguard is, given the rise of indexation, their power is growing. Their power over public companies. Now, traditionally, the thought was these index funds have very weak incentives to be shareholder activists, to take a stand. They just let management go about doing their job. But that has changed.

As BlackRock and Vanguard have gotten bigger, they've also gotten more active in adopting policies about how they will vote their shares and engage with management. They produce position papers and public documents.

Vanguard, for example, says about climate risk, by design, our engagements focus on how portfolio companies are identifying, disclosing, and mitigating potential risk to long-term shareholder value. As a result, over the last several years, many engagements included a focus on the risk that climate change poses to our portfolio companies. In these conversations, Vanguard sought to understand companies' climate risk strategies and mitigation efforts.

and the role their boards play in overseeing those strategies and providing investors with appropriate disclosures. Vanguard said that in cases where they felt companies needed to provide greater disclosure or clarity, they voted on shareholder proposals, climate-related shareholder proposals. They've also participated in proposals voting in favor of them and engaged directly with companies on diversity issues.

They write, given our views on the benefits of appropriate board diversity of skills, experiences, and personal characteristics, we conducted a proactive engagement campaign focused on the approximately 200 companies that our research indicated were lagging their peers and industry norms as they lacked any gender, racial, or ethnic diversity on their boards.

BlackRock has also participated in both engagement and shareholder proposals. They write, BlackRock believes that climate change has become a defining factor in companies' long-term prospects. We ask every company to help its investors understand how it may be impacted by climate-related risk and opportunities and how these factors are considered within strategy in a manner consistent with the company's business model and sector.

Specifically, we ask companies to articulate how their business model is aligned to a scenario in which global warming is limited to well below 2 degrees Celsius, moving towards global net zero emissions by 2050.

Now, Vanguard and BlackRock have not typically initiated shareholder proposals, but they can be highly influential in publicly supporting proposals by other shareholders. BlackRock said in 2021 it supported 47% of environmental and social shareholder proposals.

because they determined those proposals were consistent with long-term value creation and didn't unduly constrain management in pursuing strategies to create shareholder value. But they voted against proposals that they felt were trying to micromanage companies. Vanguard's approach is similar. They said that they'll vote case-by-case on the management and shareholder proposals that request adoption of specific targets or goals...

and on proposals that prescribe adoption of environmental or social policies and practices, but that they won't support shareholder proposals that are too prescriptive. There's a balance there. What is too prescriptive? The point is they are actively engaging where they are typically the biggest shareholder on these environmental and social issues.

When Vanguard and BlackRock support a particular shareholder proposal, and again, they're typically not initiating them on their own, but they're supporting proposals from other activist shareholders, that often gives those activist shareholders much more influence than they would otherwise because now they have a big asset management company behind them.

Vanguard and BlackRock's influence on other issues such as mergers and contests for control of the actual companies. If there's a hedge fund that decides they want to take over a company, has gotten 5% of the shares, the influence of Vanguard and BlackRock in that merger or that proxy battle can be significant. And why?

Potentially, knowing the power of Vanguard and BlackRock, the CEOs of these companies are more than willing to engage with their largest shareholders on issues that matter to those shareholders, that being Vanguard and BlackRock.

Vanguard and BlackRock and other asset managers can't collude together. They can't get together and decide this is how we're going to vote on this particular shareholder proposal because there are laws against that. Some of the SEC regulations say that groups of investors that hold more than 5% of an outstanding stock

and groups is not defined, it's left vague, must disclose any agreements or understandings in respect to how they're voting shares for public companies. So if there was some type of informal agreement between Vanguard and BlackRock, they would be required to disclose it. But they also are very public about their positions, and so it's very easy for Vanguard to see how BlackRock feels about a particular issue.

Clearly then, Vanguard and BlackRock have a lot of sway on public companies. And as index funds and ETFs get bigger, they control more. There was one study I saw where they estimated that at some point in the next decade or so, Vanguard and BlackRock combined could control 40% of the voting rights in publicly traded companies. Before we continue, let me pause and share some words from this week's sponsors.

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One of the challenges then of this horizontal ownership where a Vanguard, BlackRock, or other asset managers own shares in competing companies, does that disincentivize those companies to compete? This was one of the concerns that Farhad Manjoo mentioned in his article.

He gave an example. Because Vanguard is the largest shareholder in both Ford and General Motors, why would it benefit from competition between the two? If every company is owned by the same small number of people, why fight as fiercely on prices, innovations, and investments?

The jury is out on this. I looked at a number of academic studies about this. One that focused on airlines and airline pricing found that ticket prices in routes where two airlines competed, where there was horizontal ownership among the ownership of the publicly traded shares, that ticket prices were 3% to 7% higher compared to

a separate airline route where there was less horizontal ownership of the underlying shares. They found that the anti-competitive incentives implied by that common ownership were 10 times higher than the Federal Trade Commission and Department of Justice would flag as a merger of two companies that would likely enhance market power. In other words, horizontal

horizontal ownership, a Vanguard or BlackRock owning shares among competitors was almost as if the competitors were merged and weren't competing. Now, that's a controversial position.

Vanguard has also looked at this. There's a paper that I'll link to. They looked at not just specific industries because many of the papers that suggest that horizontal ownership is bad looks at a specific industry. Vanguard looked across 3,000 U.S. firms in 200 industries over a 21-year period because their thought was, well, if there's anti-competitive effects due to common ownership, that should be shown across many different industries.

and their papers, they couldn't find any conclusive evidence that common ownership hurt industry-level profit margins.

One of the other areas that Vanguard and BlackRock are very much involved in is ESG. ESG stands for Environmental, Social, and Corporate Governance. The acronym was first introduced back in 2004 in a report commissioned by the United Nations. It took a while to catch on. A study by PIMCO looking between May 2005

In May 2018, ESG was mentioned in fewer than 1% of the earnings calls that corporate management had with shareholders. But by May 2021, one-fifth of earnings calls mentioned ESG. ESG is an incredibly fast-growing segment of the asset management industry. In 2021, ESG funds grew 53%.

just in that year, to $2.7 trillion in assets.

But ESG, and we've discussed this in other episodes, is challenging because what should the criteria be? How do you measure whether a company is being environmental, social, has appropriate policies? Should they be included in the screen? Should they be excluded? And because there's such great interest, there's the temptation by big asset managers to greenwash, to

to make unrealistic or misleading claims about their environmental credentials, how well they're analyzing companies to see if they're ESG compliant.

On May 31st, the German police raided the offices of asset manager DWS. This is majority owned by Deutsche Bank. And this was part of allegations regarding greenwashing, that DWS was misleading the public about how they were going about their ESG investing.

And ESG gets particularly challenging when it comes to energy. The whole idea that West Virginia is upset at BlackRock because of their position regarding oil and natural gas and coal. But given the spike in oil prices and how the energy transition is ongoing, Vanguard announced in May that it would refuse to stop new investments in fossil fuel projects.

nor would it end support for oil, coal, and natural gas. Vanguard would still be involved in that. BlackRock said they would vote against most shareholder resolutions brought by lobbyists that wanted to ban new oil and gas production. So on one side, Vanguard and BlackRock have ESG funds. They are very involved in engaging with managers, voting on shareholder proposals, wanting to know how companies are managing climate risk,

On the other side, they're not willing to outright ban new oil, gas, and coal projects and are involved in fossil fuel investing and own fossil fuel companies.

ESG is very controversial. Stuart Kirk, the former global head of responsible investing at HSBC's Asset Management Division, was suspended last month after stating in a speech that climate change does not pose a financial risk to investors.

Whereas BlackRock is saying climate risk is investment risk. Is it any wonder that there's a lot of confusions, that there's greenwashing, that how does climate fit in creating long-term shareholder value?

What do we do then? In terms of Vanguard, BlackRock, and other asset managers getting too big, there can be legislation. Some proposals are index fund and ETFs just aren't allowed to vote because those asset management firms actually own the shares and can influence the voting and they've gotten so big, maybe they shouldn't be allowed to vote shares. Or there should be ownership caps with regards to the ETFs

amount of ownership they own in any one company. There could be regulations about engagement and how active these asset managers can be, these big index fund providers can be, in engaging with companies and sharing their views on climate risk, diversity, other social issues, or even other issues regarding mergers and acquisitions. If you go through the list of

of policies that Vanguard and BlackRock make public. It isn't just climate-related issues or social issues. They have views on all aspects of corporate management.

BlackRock and Vanguard and other index funds and ETFs have been incredibly influential in bringing down investment costs for us as individual investors. But that doesn't mean we have to invest all our assets with Vanguard or BlackRock. There are other providers that we might consider that have strong

smaller asset balances, and perhaps aren't as active in outlining their policies and their shareholder engagement. Historically, that's what index funds did. They just didn't engage. But now they're much more involved in engaging with companies, but not every asset manager is that involved. Another option is we could just own individual stocks so we can vote our own shares and own the companies that we feel most comfortable with.

Another option is direct indexing, a topic we discussed a couple weeks ago in Plus Episode 388. Direct indexing allows you as an individual with a very small account, with Fidelity only $5,000, with Schwab

$100,000, you own fractional shares in companies. So you have an ownership right, but you can exclude certain industries and certain companies. So there are other ways. If you're uncomfortable with the activism of Vanguard or BlackRock, if you think they've gotten too big, they're having too much influence on policy or growth.

Cross-ownership is making for less competition, more monopolies. There are other options out there.

I don't know whether Vanguard and BlackRock have gotten too big. If you look at some of the biggest names, generally they own less than 10%. They're not allowed to collude with each other. But there is a degree of concentration where the views of BlackRock and Vanguard are influencing corporate America and corporations around the world. And whether that's a good thing or a bad thing probably depends on whether you think climate change...

Diversity and some of these other issues are indeed investment risk that should be managed. I think they are. I'm just not necessarily sure this is the best way to go about it. We'll see how it evolves, but the trends appear to be these asset management firms will continue to get bigger because there are economies of scale. As they manage more assets, they can drive lower cost. That's episode 390. Thanks for listening.

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