Millions of fund investors get a vote

Investing in index funds has conquered the world. In Decemberfor the first time, entrusted to American investors more money index funds than actively managed funds, where a manager chooses shares or bonds for you.

There is good reason for the popularity of index funds. For most people, owning a small piece of the entire market, which you can do at low cost with an index fund, has been more profitable than buying and selling securities, either alone or through a manager.

But the relentless growth of index funds comes at a cost. A major problem is that the most diversified funds own shares in every publicly traded company on the market, and if you don’t like a company or its specific policies, you’re stuck. You couldn’t even cast your vote on issues you thought were important because until recently the fund managers insisted on doing it for you.

Well, that’s changing in a big way.

BlackRock announced this month that it is expanding an experimental program to give investors six types of policy choices — such as a focus on climate change or a preference for religious values ​​— when voting on corporate issues. State Street already has a similar program running, and Vanguard is also tiptoeing into this type of voting choice.

All told, the three giant fund companies have given tens of millions of investors, with $4.6 trillion in assets, a way to express their opinions on corporate issues. This is certainly an improvement. And it could ultimately lead to profound changes across corporate America, even as it eases some thorny problems for the big index fund companies.

The problems

According to scientists like John Coatesthe author of “The problem of 12: When a Few Financial Institutions Control Everything,” the growth of index funds has had the unintended consequence of declining shareholder democracy.

A handful of index fund companies, led by BlackRock, Vanguard and State Street, have become universal owners, Mr. Coates, a Harvard law professor and former Securities and Exchange Commission official, said in an interview.

“Index funds have too much power,” he said. “They are the largest shareholders of almost every listed company. And the trend of over-concentration of ownership continues.”

Until recently, the directors of index funds – and not the millions of people who invest in their funds – had all the power to cast votes, or proxies, for fund shareholders. This voting power gave fund directors a potentially decisive vote on crucial matters, such as how much a company’s CEO was paid, whether a company’s operations were environmentally responsible, and whether it treated its employees fairly.

For example, three years ago, BlackRock, State Street and Vanguard cast crucial votes in a proxy battle at fossil fuel giant Exxon Mobil, helping elect three dissident members to the board of directors with the aim of pushing the energy giant to reduce ecological footprint.

But the fund companies are uncomfortable in the public spotlight. They have become embroiled in the culture wars – criticized by the left for failing to adequately embrace environmental concerns and by the right for placing excessive emphasis on them. State Street and BlackRock, among others, have recently backed away from their full-fledged commitments to combating climate change, saying they need to focus even more sharply on their purely financial duties.

Given that context, it is not entirely shocking that fund companies are beginning to give a substantial degree of proxy voting choice to shareholder financing – in effect sharing responsibility for difficult decisions with individual and institutional investors, such as pension funds.

Whatever the motivation of the fund companies, the changes in voting choice could change the balance of power within the business community.

Vote choice

What the companies are experimenting with isn’t true pass-through voting, which requires asking millions of fund shareholders how they want to vote in thousands of specific proxy contests each year, and then actually casting those individual votes accordingly.

Instead, the companies offer investors something simpler and more manageable: broad policy choices.

BlackRock for example announced on Feb. 13 that it offered a “trial” voting choice project to three million individual investors in a simple, popular S&P 500 index fund, the iShares Core S&P 500 ETF. (That’s short for exchange-traded fund, an index fund that can be traded on the stock exchange throughout the day.) Many pension funds and other institutions that invest with BlackRock can already cast proxy votes at their discretion.

At BlackRock, $2.6 trillion, or half of the company’s stock index assets, are eligible for what they call Voting Choice. “Customers with total assets of $598 billion will use Voting Choice starting December 29, 2023,” the company said in an email. It added: “That amounts to approximately 25 percent of total eligible assets.”

State Street has already made it $1.9 trillion in assets – more than 80 percent of its total stock index assets – is eligible for inclusion in its proxy choice program. That includes a wide range of popular ETFs, but not the largest S&P 500 ETF, known as SPY.

About $250 million of fund assets held by individuals, as well as about 10 percent of institutional assets, are voted under six different policies: Lori Heinel, Chief Investment Officer at State Street Global Advisors, said in an interview. “We don’t consider what we do as an experiment. We are on the market. It’s available.”

Vanguard, which started the first commercially available index fund, is procedure slower. Six of its funds, with $100 billion in assets, have been included in what the company calls an experiment. They are the S&P 500 Growth, Vanguard Russell 1000, ESG US Stock ETF, Mega Cap and Vanguard Dividend Appreciation index fund. This is just a start, the company said in an email.

“We are using our pilot to gather customer feedback, refine our approach and optimize the investor experience as we expand to more funds,” Vanguard said. It says it offers four choices, but two are more like non-choices: don’t vote at all, or let Vanguard vote for you.

How it works

What this all means in practical terms is that if you are an eligible shareholder, you can continue to let a fund company make the voting decisions for you (or, with Vanguard, withhold your vote). But you now have other options.

If you choose, your vote will be cast based on recommendations from a shareholder advisory service that is in line with a specific policy.

These are the options at BlackRock. Three are advised by Institutional Shareholder Services:

• Socially Responsible Investment (SRI) Policy.. It is explicitly aimed at investors who require companies to ‘behave in a socially and environmentally responsible manner’.

• Catholic faith-based policy. It also generally requires ‘socially and environmentally responsible’ behavior. But last year, this policy emerged, according to BlackRock against a failed one proposal at Coca-Cola the company is asked to report on how state abortion restrictions could impact its business.

• Global governance-oriented policies. This is what most boards would prefer, with votes ‘generally aligned’ with the boards’ recommendations on ‘environmental and social matters’.

Three policies come from Glass Lewis:

• Benchmark policy. It encompasses the classic principle of good governance. Many proxy votes are not binding, but with this policy, boards must act as if they are and respond to shareholder wishes.

• Climate policy. The board adheres to strict environmental standards. The policy also focuses on gender diversity: “If less than 30 percent of the board consists of women, the climate policy will vote against all sitting male nomination committee members for large and medium-sized companies.”

• Corporate governance-oriented policies. It emphasizes “the fiduciary responsibility to drive long-term economic shareholder value.”

How this policy plays out in practical voting is not always the case clearly. On many issues they will certainly lead to different results. A proxy vote last year that asked Exxon Mobil to report how workers and communities with plant closures are affected by the fossil fuel transition is a good example.

In an email, BlackRock said Exxon management, BlackRock’s own policymakers and the Board Aligned policy all opposed the resolution. But the Catholic faith-based policies, socially responsible investment policies and Glass Lewis benchmark policies all supported this.

Unlike the proxy battle at Exxon in 2021, this one failed. BlackRock is Exxon’s third largest shareholder, according to FactSet. The only entities with larger stakes are Vanguard and State Street.

This fragmentation of the immense votes at BlackRock is perhaps what Larry Fink, the asset manager’s founder and CEO, meant when he said in a speech: letter told the company’s shareholders last year: “There are a lot of people with opinions about how we should handle our customers’ money. But the money doesn’t belong to these people. It’s not ours either. It’s ours customersand our responsibility and duty are to them.”

State Street’s policy choices are similar to those of BlackRock. Vanguard’s two program choices include a board-aligned policy and an ESG or climate policy.

Looking forward

How voting programs will influence votes this corporate proxy season, which is just beginning, is an important question. Lindsey Stewart, director of investment stewardship research at Morningstar, closely follows the voting patterns of fund companies. He says he can’t say if they made much of a difference last year.

Professor Coates says current voting choice programs are complex and may not attract much interest unless companies find ways to focus on the most pressing issues each year. He mentioned the perennial battle over labor issues at Starbucks, or major climate issues at fossil fuel companies, or disputes over reproductive rights, as areas that companies could emphasize. Translating voting policy into actual votes is important, he said, and must be done clearly, before proxy voting.

“I consider this progress, but it is far from perfect,” Professor Coates said.

At least now there are better prospects for fund shareholders, who had been condemned to silence, to finally have a voice.