Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
The writer is founder of Greenwich Associates, an author of 19 books and former board member of Vanguard
Index or tracker funds are remarkable in two ways. First, they continue to deliver exactly what they promise to investors, a most unusual characteristic among investment offerings.
Second, no matter how well they to do in attracting ever more investors with their low fees and consistent performance, they also continue to be an important cause for “concern” even though the “concerns” keep changing and seem to have little justification when examined.
Years ago, the “concern” was that index or tracker funds were not striving to beat the market, making them somehow unpatriotic. Ads were run with Uncle Sam, dressed in red and white stripes with a star spangled top hat, calling on investors to stamp out indexing.
The “passive” description of such funds was cast as pejorative. What business, political or military leader would tolerate being called “passive”? The term had its origin in the electrical engineers who were key to the early development of index funds. They innocently brought terms with them. For electrical engineers, the wall socket with holes is “passive” while the prongs of the plug are “active” with no negative connotation. But, in a different context, the word passive was used to malign index funds.
With objective reports from S&P Global showing that around 85 per cent of active managers of US funds focused on large capitalisation stocks underperformed the S&P 500 index over last decade, those concerns have faded away.
However, in recent years, the “concern” with indexing or tracking has centred on the reality that three very large managers seem to dominate the market. This is despite at least a dozen other managers offering such funds, several large institutions produce or private label their own funds, and many managers “closet index” significant parts of the assets for which they are responsible.
The Big Three — Vanguard, BlackRock and State Street — have been accused of such potential wrongs as possible collusion or being unwitting vehicles for collusion on the prices charged by companies in which they invest.
That touches two contradictory narratives. One “concern” is that tracker funds have no incentive, given their low fees, to engage with management. The other is that large index funds and the small number of people at each firm who do the index matching mean a few unknown and unaccountable people wield far too much power.
This remarkable misunderstanding can only be explained by not having the facts that are readily available on each manager’s website. Take Vanguard as an example. It employs more than three dozen professionals in evaluating 130,000 proxy votes each year.
In the tradition of effective communication — tell ‘em what you’re gonna tell ‘em; tell ‘em; and tell ‘em what you told ‘em — Vanguard publishes its voting policies and offers to meet any corporate executive interested in going deeper into the reasoning behind each policy. It then reports each year how it voted by category of issue divided between proposals advanced by management compared with proposals advanced by shareholders.
For example, in a recent year, out of eight categories, Vanguard voted with management on board composition 90 per cent of the time compared with 87 per cent of the time with shareholder proposals. On matters of strategy and risk, it voted 100 per cent of the time with management versus 22 per cent with shareholder proposals.
When Vanguard compares its voting with the leading proxy voting advisory firm, it reports that it voted “No” 7 per cent of the time when ISS recommended voting in favour and voted “Yes” 9 per cent of the time ISS recommended being opposed.
Taking a macro view, most corporate executives would consider these the most desirable characteristics of an ideal shareholder: focused on the long-term interests of the company; generally supports management; maintains ownership through thick and thin; does homework to be well informed; votes on all proxy matters; and consistently supports managerial best practices.
Index trackers are necessarily long-term shareholders. So they have strong reasons to focus on the long-term best interests of the companies they must hold.
If, as we are so often told, “sunlight is the best disinfectant”, the systematic full disclosure by index managers sets a high standard for all investment managers. That’s another good reason investors are glad indexers are active, not passive as shareholders and why wise corporate executives welcome their increasing ownership.