Rise of Passive and the Growing Concentration of Voting Power
ETF Prime Host Nate Geraci was joined by VettaFi’s financial futurist Dave Nadig and VanEck’s Jan van Eck to explore concerns around the growing concentration of proxy voting power among several large fund companies. For the second section of the show, Newfound Research’s co-founder Corey Hoffstein joined Geraci and Nadig to unpack the Return Stacked Bonds & Managed Futures ETF (RSBT).
The Rise of Passive
With the rise of passive investing, shareholder voting has been consolidated into the hands of a few big asset managers. Fresh off a piece written by Jan van Eck provocatively titled, “ESG Died in 2022”, Nadig and Geraci began the conversation by laying out how we got here, with Geraci wondering if it is as simple as the rise of passive indexing resulting in the consolidation of shares controlled by a small number of large asset managers.
“I think that is 90% of it,” Nadig concurred, noting firms like Apple are currently roughly 7-8% owned by Vanguard and 6-7% owned by BlackRock. This tracks across numerous mega-cap companies. Nadig said, “its legitimate that people are concerned about ownership and concentration of ownership. The question is, what do you do about it?” With the outsourcing of social safety nets and retirement accounts now requiring that people who seek to save for retirement be participants in the market, it is not surprising that the biggest issuers are controlling a continuously growing piece of the shareholder pie.
Asked whether political discourse has been a contributing factor, Nadig said, “I think what’s driving the focus right now is this idea that all of sudden it seems like who runs corporations really matters.” The heightened engagement comes on the heels of broader awareness about a host of issues, ranging from the impacts of climate change to the day-to-day management of individual Tesla factories in California. “If you care, the way you impact companies – we now understand – is you vote,” Nadig added.
The Hudsucker Proxy Vote
Dipping into his experience managing funds, Nadig walked through what proxy voting is an how it works. He pointed to annual meetings typically being boring affairs, with up and down votes on uncontested seats for board members. “Increasingly, however,” he noted, “there are shareholder proposals which can come in the likes of everything from ‘we would Exxon to disclose more of what they are doing for carbon transition’ to ‘we would like to get a diversity report so we understanding what our hiring practices are inside the company.’ Those types of proposals can be a bit more contentious.”
The 10-15% of the vote block owned by large firms has a powerful ability to direct corporate governance, particularly in these contentious issues, and asset managers might not necessarily vote in a way that aligns with the owners of the assets they are managing.
Nadig pointed to Engine No. 1’s successful efforts to get two directors placed on the Exxon board as an eye opening moment for many as to the power of the proxy vote.
Speaking to the potential problems with having a great deal of power concentrated in the hands of a few shareholders, Nadig said, “you can imagine all sorts of backroom deals.” He explained that it’s easy to see how a small group of people could make decisions about a company that far afield from the economic life of that company. “In reality it’s nowhere near that nefarious,” Nadig added. BlackRock and other big issuers tend to have large teams in charge of corporate governance and frequently explain how they are going to vote and why well in advance. However, Nadig noted that how shares are being voted matter, particularly around ESG issue. “I think there’s reasonable discussion there. Should a proxy voter only be voting for the next quarter or should they be voting for the next year or next decade? You make different decisions based on your answers.”
Driving the Industry Forward With Jan van Eck
After taking a moment to discuss the puppy play area at Exchange (as well as the ideas and discussions in the biggest ETF conference of the year), Geraci dug into van Eck’s piece. “It’s only going to continue. The big companies have huge market share,” van Eck said, noting that going forward, “they’re going to own more and more of corporate America.”
Van Eck sees his piece as getting the industry to start thinking about these issues in advance. “There are big differences depending on what side of the aisle you are on, but we generally agree we should focus our attention on where there is a concentration of power and we should provide transparency around that through regulation,” he said.
Though the big issuers own huge chunks of many companies, there are institutions and individuals who outweigh them. Nadig noted Softbank owns 25% of Alibaba and Bezos owns 50% of Amazon, leading him to wonder, “why is that less valid as an ownership concentration than Fidelity or Capital Group?”
“There’s a lot of control Vanguard can exercise – I’m just picking one name – over a company their funds own just by having a conversation with their director,” van Eck said.
Nadig pushed back, pointing to how much more transparent a passive firm is than an active manager like Fidelity, “if the issue here is ownership, why does it matter who the ownership is concentrated with?”
Proxy Voting Solutions
Geraci pointed out that, “low cost indexing has been beneficial to investors,” further complicating the possible solutions.
Disclosure is one possible solution, though van Eck noted “over disclosure is no disclosure.” Nadig applauded companies that are going above and beyond and producing readable discussions about the important issues, though admitted it’s hard to mandate that.
Federal regulation could be another solution, but there are problems baked into that solution as well, according to van Eck. “There’s a lot of judgment involved here.”
Van Eck’s preferred solution is to cap the percentage of company shares any index provider can vote on. “I think it’s, in a way, a kind of consensus,” he said, continuing, “5% still gives companies a lot of input.” It also doesn’t stop activist investors.
“I think the end state here is pass through voting,” Nadig said, pointing to the work Tumelo has been doing to build the back end rails for companies to ask their shareholders how they want to vote.
Hoffstein on RSBT
Hoffstein discussed the new Return Stacked Bonds & Managed Futures ETF (RSBT). Hoffstein said, “the basic idea here is for every dollar an investor puts into the fund, the strategy is seeking to provide a dollar of core U.S. fixed income exposure as well as a dollar of managed future exposure.” The core idea is to help investors access alternatives efficiently.
Making room in a portfolio for alternatives means surrendering stock or bond exposure, but RSBT solves for that by “stacking” the alternatives exposure on top of the bonds. Hoffstein said this strategy is especially appealing for investors who want that alternative exposure for the moments where it matters but don’t want it during decades where it underperforms.
The fund is leveraged, but Hoffstein said “what we’re trying to do is use leverage to unlock the benefits of diversification,” instead of doubling down on a risk. “We think that’s a prudent use of leveraged.”