Active Ownership

Osbon Capital launched in 2006 as an index boutique focused on ETFs and the emerging index strategy. At that time, Vanguard had just passed $1 trillion in assets under management and indexing and ETFs were still a relatively young concept. ETFs held just $300B in total assets at the time, and John had the foresight to predict that index ETFs would become the overwhelmingly dominant trend in markets and asset management. Today, the largest ETF, the S&P 500 SPY ticker, holds $414 billion, ETFs in aggregate hold roughly $6.5 trillion, and Vanguard’s assets have surpassed $7 trillion.

The index and ETF market dominance raises questions about the future of ownership, leadership and voting rights. John Coates of Harvard recently published on this topic, “The Problem Of Twelve: When a Few Financial Institutions Control Everything.” Today, Vanguard, Blackrock, State Street and Fidelity own roughly 25% of large corporate America. That number has been growing by approximately .5% each year consistently. 

This is also true of private equity, which has grown even faster because it tends to buy entire companies rather than shares. It’s estimated today that one in seven people in the US work for private equity fund-owned companies, whether they know it or not. My sister works in the education field for a private equity-owned company. I’m not sure about the measurement of this number, but Coates says private equity is on track to run a third of the US economy. 

The interesting part about this concentration of power is not where the returns and value accrue but where the voting power is concentrated. On the public equity side, it’s the big four mentioned above. On the private equity side, it’s KKR, Apollo, Carlyle, and Blackstone. And on the indexing side, it’s providers like Russel, Dow Jones and MSCI.

Coates considers this topic more of a dilemma and less of a problem. There are a few questions that remain.

• What is the upper limit for ownership among the top 10 institutions? What happens when they own more than 50%?
• How will regulations support active participation in ownership when so few people are involved? The executives of these companies need the workforce to meet with every single company and attend every meeting.
• How will “passive” holders vote when forced to choose between Ford and GM or United Airlines and American Airlines? 

The one thing that investors who look outside of indexes should be aware of is the massive buying pressure introduced when a company is added to a primary index like the S&P 500. Last week, the S&P committee announced that AirBnB and Blackrock were being added. Index rebalances introduce a lot of buying and selling power, which can move share prices considerably in the short and long run. This is not a comment on future AirBnB or Blackrock stock performance.

S&P 500 companies need to show positive earnings to be included, which is not something that modern technology companies have prioritized. Tesla was late to the S&P 500 because it didn’t show positive earnings until a few years ago, so index investors largely missed Tesla’s gains. There are many examples of young companies that are likely contenders for S&P 500 inclusion when they achieve positive earnings.

Ultimately, this concentration of power is something for investors to watch. Indexing and the economies of scale offered by the major investment firms have created enormous value for investors. That success is getting too large and needs to be managed in the coming years and decades.