Vanguard’s warning last month that US regulators were eyeing the possibility of restricting stakes in certain sectors caught the attention of the wider ETF industry, but is this another case of ‘passive power’ bashing or the reality check investors needed?
The asset manager filed disclosures across several funds with the Securities and Exchange Commission (SEC) highlighting the possibility regulators could enforce caps on its physical equity ownership of individual banks and utilities.
Currently, regulators allow asset managers to exceed 10% ownership stakes provided they do not seek management roles.
If implemented, passive giants would be required to sell their physical exposures in these sectors, instead relying on derivative-based exposure which could come at an additional cost for investors.
The caution again raises the issue of the dominance of the ‘Big Three’ – Vanguard, BlackRock and State Street Global Advisors (SSGA) – which has threatened to boil over throughout the meteoric rise of passive investing.
ETFs and index funds have found themselves in the firing line from some big US hitters over the past few years, including Elon Musk and Bernie Saunders, with the latter stating “democracy would not survive” at current ownership levels of the ‘Big Three’.
The trio own over $21trn in assets and controls roughly a quarter of the votes of the entire S&P 500, according to Martin Schmalz, professor of finance and economics at Oxford Saïd.
The potential of further capping limits by the SEC on the physical ownership of equities is the first that could dramatically hit investor portfolios, with fund costs and performance directly impacted by the requirement to hold derivatives.
Industry bodies have been quick to debunk the myths associated with the warning, noting it risked harming “tens of millions of American investors”, although in reality the damage is likely to spread much wider.
In a statement, Vanguard said: “It is not always possible to secure relief and there is an increasing amount of uncertainty around how much ownership limitations relief regulators will grant to asset managers like Vanguard.”
One way issuers have tried to alleviate regulatory pressure is by implementing proxy voting programmes. BlackRock and SSGA both expanded their voting powers last year, with the former announcing plans to include retail investors in its proxy voting choice programme on its largest ETF, the $516bn iShares Core S&P 500 ETF (IVV), while Vanguard also said it would trial proxy voting.
The success of these programmes has yet to bear fruit however, despite being their main defence against passive power criticism.
It is the latest in a series of attacks on the ‘Big Three’ and its impact on markets, in addition to the idea the rise of indexing is distorting markets. Investors must keep an eye on developments as one that has the potential to pose a real threat to portfolios.
