End of week thoughts on a variety of issues impacting investor relations, the markets and the investment community, from Chris Taylor, EVP, Global Research, Thought Leadership & Partnerships
Happy 40th to the Index Fund!! (kind of)
The esteemed John Bogle, Founder of Vanguard Investments and father of the index mutual fund, recently penned an article for the CFA Institute’s Financial Analysts Journal celebrating the 40th birthday of the first index mutual fund, the Vanguard 500 Index Fund. Mr. Bogle chronicles the start of the index fund and the skepticism that it met when launched and in typical Bogle fashion, presents a clear-minded argument on the virtues of index investing. Additionally, as he is wont to do, Mr. Bogle takes a contrarian view on the virtues of the growth in ETFs, which he views primarily as instruments for speculation that can carry greater risk due to the less-diversified portfolios of many ETFs. If Mr. Bogle were still the Chief Executive of Vanguard, my guess is that the firm’s ETF product portfolio would be far more limited than it is today. Regardless, I encourage you to read the article.
With that said, Mr. Bogle, with the help of Morningstar, catalogs the significant growth in equity assets that have flowed to indexed portfolios, inclusive of his preferred closed-end mutual funds and ETFs. Here are a couple statistics that stood out:
–Since 2005, assets in index funds have grown from $868 billion to close to $4 trillion (that’s trillion, with a T) in 2014;
–Assets in equity ETFs account for $1.7 trillion of the $3.4 trillion of the total equity assets held in index funds or a full 50% of equity index fund assets.
The growth of indexing has come at the expense of investment managers that actively manage their portfolios. Lagging performance and higher fee structures have put considerable pressure on the value proposition of many active managers. The shift of equity assets from active strategies to passive index strategies has direct and indirect ramifications for investor relations professionals. For companies in the S&P 500 and many other companies, the top of your shareholder lists are going to have some names in common. In particular, the “big three” of indexing–, Vanguard, BlackRock and SSgA–hold sizable positions in hundreds of companies.
We’ve come up with a few data points that we think best illustrate the impact that the growth of index investing has had on equity ownership and active managers. The following tables detail the ownership by the big three of indexing in companies in the S&P500 to depict their growing influence.
A few quick points:
–Vanguard ranks as a top-5 institutional shareholder of every S&P 500 company. Wow.;
–More than 75% of all S&P 500 companies have every member of the big three as a top-5 institutional shareholder;
–From the end of 2009 to the end of 2015, the group altogether has moved from an average shareholder ranking of 4.6 to 3.2. Vanguard’s ranking on its own is now 1.7.
–To conclude, if you don’t have plans for a governance-focused roadshow, you should get one on the calendar.
The comparative chart below is one we have presented before in prior editions of our BetterIR publication. It’s worth revisiting as it is a microcosm of the battle for assets between index and active management strategies. The chart provides a cumulative flow of equity assets (positive or negative) into Vanguard and the Capital Group. We’ve done this at the firm level using 13F filings and have aggregated the various subsidiaries of Capital. While the battle for assets is not a two-firm struggle, the chart clearly shows who is out in front, and it’s not even close. Since the end of 2009, inflows into Vanguard totaled more than $900 billion, while at the same time cumulative outflows from Capital are more than $175 billion.
Only recently has Capital stanched the outflows, partially due to money coming into its Income Fund of America, as investors look for yield in a low-rate environment. From an IRO’s perspective, this divergence of fortune should be a concern. Capital is considered an ideal shareholder by most companies, smart and long-term oriented. IR and management interaction, along with valuation obviously, can have a meaningful impact on a decision by Capital to take a position in your company. Fundamentally, this is what IR is about. Yet, with Capital and other active managers unable to grow assets, while index investors continue to grow their percentage of institutional assets, the impact of IR is reduced.
The surge of assets flowing into passive strategies at the expense of active strategies will have an impact over time, on not only the buy side (that’s pretty clear), but also the sell side. Asset gathering is the lifeblood of investment managers. A slowdown in asset gathering will impact the resources that active managers can give to the investment process. Fewer active assets will result in fewer analysts and portfolio managers, less experienced (i.e. cheaper) staff and less money spent with the sell side, which will then continue to have a knock-on effect on sell-side coverage and the experience of the analysts writing research.
Interacting with index investors differs greatly compared to interacting with your active investors. Less frequent sit-downs will be required by index investors and when you do sit across the table from them, governance issues, not your financials and strategy, will be at the top of their agenda. Given index investors’ inability to “vote with their feet” and sell stock of companies they don’t favor, they will seek to improve performance through improved governance and other extra-financial issues. And, oh yeah, while the big three all have dedicated Governance teams and detailed Governance policies, they also utilize firms like ISS and Glass Lewis as advisors. I’ll also take this time to point you to a great piece by my colleague, Brian Matt, that was recently published in Ethical Boardroom, which includes an analysis of voting by the big three across several proposal categories.
Reversing the flow of assets into indexed products will require sustained outperformance by active managers against the major indices and possibly an adjustment of their cost structure. In the interim, IR will need to dig deeper and work harder to find active investors and constantly improving fluency in corporate governance matters is a must.
Thanks to my colleagues Matt Davis and Chris Stroh for assistance with the data elements of this post.