Tesla founder and CEO Elon Musk took to Twitter on Sunday to express his concerns about passive investment’s impact on shareholder engagement and went as far as to say this modern investing phenomenon has “gone too far”.
Responding to a tweet complaining about the role of investment managers, Musk said: “Decisions are being made on behalf of actual shareholders that are contrary to their interests. Major problem with passive/index funds!”
A separate post highlighted Modern Portfolio Theory and the rational approach of buying the market, however, it suggested the market reflects fundamentals only because active investors make it so.
Musk replied: “Exactly. Right before he died, Jack Bogle (of Vanguard fame) said index/passive funds were too great a percentage of the market and he really knew what he was talking about!
“There should be a shift back towards active investment. Passive has gone too far.”
Exactly. Right before he died, Jack Bogle (of Vanguard fame) said index/passive funds were too great a percentage of the market and he really knew what he was talking about!— Elon Musk (@elonmusk) May 1, 2022
There should be a shift back towards active investment. Passive has gone too far.
The billionaire entrepreneur becomes only the latest to voice such concerns about both the scale of ownership and also less engaged ownership approach tacitly encouraged by passive investment.
Last year, Robin Wigglesworth, author of Trillions: How a Band of Wall Street Renegades Invented the Index Fund and Changed Finance Forever, told ETF Stream: “ETF ownership is one of my biggest concerns. We all need to be concerned about the inevitable endpoint of the economics of indexing.
“The scale nature of the index industry means the big will naturally get bigger and barring any unforeseen regulatory intervention, BlackRock and Vanguard are going to become even more titanic than they are today.
“At some point, they will control the majority of the votes of every major company in the US and globally. This will be one of the defining battlegrounds for index funds and ETFs in the coming decade given the trend shaping the market today.”
Offering a counter, Eric Balchunas, senior ETF analyst at Bloomberg Intelligence, said: “Bogle definitely wanted more competition from fund companies because he saw Vanguard/BlackRock having too much voting power but he always advocated buying low-cost index funds.”
Balchunas then recited a quote from the Vanguard founder, featured in his new book, The Bogle Effect: How John Bogle and Vanguard Turned Wall Street Inside Out and Saved Investors Trillions: “I would say index funds are the last, best hope for corporate governance…because they are the only true, long-term investors.
“Corporate governance should be based on long-term factors affecting the corporation, not a bunch of traders who want you to report higher earnings going to try to get on your board for a minute, and in a moment…realign the entire company and then all will be well. It just does not happen.
“In fact, the reverse is more likely to happen. The old Wall Street rule was, if you do not like the management, sell the stock.
“The new index fund rule is, if you do not like the management, fix the management because you cannot sell the stock.”
Rob du Boff, ESG analyst at Bloomberg Intelligence, added: “I would put a little more faith in passive [to vote in an ESG manner] because they have economies of scale.
“They come up with a thoughtful policy and then they can execute across thousands of companies they hold a stake in. They also have the expertise in engaging with these companies, as well as trying to meet them in the middle.
“Also, if you are a passive issuer you are not going to sell yourself on stock selection but on how good a steward you are of capital, there is a much bigger focus now paid to how you are as a steward, which also pushes them to be more thoughtful in their voting.”
However, it cannot be debated passive investments are now a force with market-shaping power. BlackRock, Vanguard and State Street Global Advisors now own 20% of all large, listed US firms on behalf of their clients. Common ownership of US companies by asset managers also exploded from 10% in 1980 to 80% in 2017.
Harvard Law School’s John Coates warned previously that passive management vehicles could become the “greatest concentration of economic control” in our lifetimes, a prospect that should inspire pause for thought – especially when asset managers are being accused of conflicts of interest favouring client companies, as argued in a paper by non-profit organisation As You Sow.
Bloomberg Intelligence’s Balchunas argued passive product issuers should look to democratise voting – a step BlackRock has already partially taken by offering direct voting rights on 40% of its equity index assets. However, the extent to which this can be applied across the board – and to retail clients as well as professionals – will be a conversation of political significance and regulatory interest.