How the ‘Market Share Opportunism’ of Investment Advisers is Harming Investors and Public Companies

The competitiveness of our public companies is being weakened by the market share opportunism of those who manage (investment advisers like State Street and BlackRock) our mutual funds and exchanged traded funds (ETFs). Instead of maximizing shareholder wealth through voting and engagement, what is maximized is an investment adviser’s market share of the investment fund market.

The result is economic harm to companies and the lowering of financial returns for the tens of millions of US citizens who own shares in stock mutual funds and ETFs, those who hold common stocks directly in brokerage accounts, and beneficiaries of public pension funds. The only way to mitigate this investment adviser opportunism is for the SEC to establish and enforce new fiduciary duties for investment advisers that keep them focused on maximizing the financial value of their funds when exercising their shareholder voting authority and engaging with portfolio companies. 

To maximize market share, shareholder voting and engagement with portfolio companies has become increasingly based on political values, not wealth maximization. Such voting, no matter what part of the political spectrum it represents, pressures corporate boards into making decisions that are not expected to maximize shareholder value. Without such maximization, companies are less likely to enter into the most profitable supply chain arrangements, human capital decisions, and investment opportunities. This makes them less competitive compared with those companies who do not face such pressures. 

The Drive for Market Share

The problem dates back to 2017 when the Big Three investment advisers to index funds, BlackRock, Vanguard, and State Street, finally figured out a way to differentiate themselves from their smaller rivals in the offering of index funds. Such funds, such as those tied to the S&P 500 index, are basically indistinguishable from one another. Therefore, without some sort of brand differentiation, increasing one’s market share would be extremely difficult.   

Finding a way to increase market share is critical to the success of any investment adviser. Increased market share leads to increased assets under management (AUM).  For the Big Three, given the extremely low fees that are paid for the management of index funds and their inability to control stock market fluctuations and long-term growth in the value of the stock market, the only way to proactively increase profitability is to increase AUM through an increase in market share. 

The required marketing strategy turned out to be targeting younger investors, such as millennials, who were on the cusp of inheriting the enormous wealth accumulated by their parents, the baby boomers. State Street was the first to implement this strategy when it unveiled its ‘Fearless Girl’ statue on Wall Street and announced a new voting policy where it would vote against board nominating committee chairs if the board did not include at least one female director.  BlackRock has now increased that requirement to two. 

While this one-size-fits-all constraint on board decision-making is desirable from a social justice perspective, what is lost is the ability of the board of directors to identify the optimal mix of board nominees for purposes of wealth maximization. Nevertheless, the announcement was considered a major marketing success.

What gives the Big Three a competitive advantage in this marketing endeavor is the enormous amount of delegated shareholder voting authority, provided by the investment funds they managed, that each possesses. As of year-end 2019, the Big Three collectively managed, on average, 21.4% of the shares of those companies that make up the S&P 500 and each managed positions of 5% or more in more than 95% of those companies.    

To carry out their marketing strategy, the Big Three must align their voting power and resulting engagement power with the left-leaning political values of young investors. Such values are referred to as ‘woke’ by their detractors and the tools for their implementation are voting and engagement policies that take into consideration environmental, social, and corporate governance concerns (ESG). 

For example, BlackRock engages with portfolio companies on ways to solve social and economic issues; advocates for the rights of stakeholders such as workers, business partners such as suppliers and distributors, clients and consumers, government, and the communities in which they operate; and comments on how stakeholder relationships should be structured at portfolio companies. 

The Big Three used their voting power to take a tough stand against oil and gas companies, for example, when the Big Three backed Engine No. 1’s successful proxy fight at Exxon Mobil despite the fact that Engine No. 1 did not take a significant stake in Exxon Mobil’s stock (only $40 million worth) and had no specific recommendations to enhance the company’s stock price or move the company into profitable business lines with low carbon emissions. The Big Three allegedly provided their support only because of their desire to be perceived as investment advisers who are making a difference in helping to mitigate climate change. What is worse, the ordeal provided more of a distraction from the fight against climate change rather than a solution.  

Smaller Investment Advisers and Anti-Woke Marketing

It has taken some time, but smaller investment advisers have started to figure out how to utilize shareholder voting and engagement as a means to enhance their market share. Engine No. 1, capitalizing on the publicity it achieved in its successful proxy fight at Exxon Mobil, launched an ETF indexed to the S&P 500. Ironically, this fund will now compete with those S&P funds offered by the Big Three. 

Strive Asset Management (‘Strive’) now offers a number of indexed ETFs targeted to those investors who are tired of ‘woke’ policies permeating the board rooms of public companies. For example, public pension funds in red states such as Florida, Texas, West Virginia, and Louisiana have begun pulling funds that were invested at BlackRock. In that regard, Strive plans on using its shareholder voting and engagement power to advocate for political values that can be referred to as strongly conservative or ‘anti-woke.’

According to Strive’s website, ‘[V]oting and advocacy decisions are made with the sole interest of maximizing the value of our clients’ investment accounts – with no “mixed motivation” to also advance a social objective.’ Yet, that statement appears merely aspirational, at least in terms of maximizing value.  For example, Strive’s voting at and engagement with Apple.   

Strive initially engaged with Apple by sending the company a letter asking it to desist from hiring based on diversity: ‘On behalf of our clients, we write to deliver a simple message to your board: hiring should be based on merit – not race, sex, or politics.’ Fair enough, but that is only part of the equation that Strive must solve. It must also explain how this will enhance employee productivity and not reduce it as a result of creating a misalignment between company and employee values. I doubt Strive can do this as it has made no claim that it is adequately informed regarding any part of Apple’s operations, strategies, or prospects, including how best to manage and optimize its human capital.       

Another example is Strive supporting a 2023 shareholder proposal that required Apple to ‘report annually to shareholders on the nature and extent to which corporate operations depend on, and are vulnerable to, Communist China.’  In supporting this proposal, Strive was advocating for shareholders to become participants in how Apple manages its supply chain. It is doubtful that Strive or any other of the shareholders that supported this defeated proposal had any idea on how to successfully accomplish this complex and ongoing task.  For purposes of shareholder wealth maximization, that is why we have the board and executive management. 

In sum, these two initiatives look more like the implementation of a marketing strategy to gain the business of public pension funds in red states, or other strongly conservative investors, rather than an attempt to enhance shareholder value.   

The Need for Stricter Fiduciary Duties

Increasing market share is the key to increasing an investment adviser’s assets under management, especially for those who focus on managing low-cost index funds. As discussed above, targeted shareholder voting and engagement can be used to this effect.  But this marketing tool, if used in alignment with the political values of a certain investor class, no matter where on the political spectrum, can significantly interfere with the implementation of wealth maximizing decision-making by the most informed locus of authority in a public company—the board of directors.

As noted above, this will cause economic harm to targeted companies and result in lower financial returns for investors. Nevertheless, investment advisors will still be tempted to pursue this approach because an expected small positive movement in market share will, in terms of assets under management, overwhelm any expected loss in the value of an index fund or family of funds from its voting and engagement that does not seek wealth maximization.    

To drive out the economic and financial harm caused by shareholder voting and engagement based on political values, strict fiduciary duties must be applied to investment advisers. These duties must direct investment advisers to focus solely on the financial interests of their beneficial investors, not their own.  Unfortunately, the fiduciary duties now in place are far from the dicta used by Chief Judge Benjamin Cardozo in the famous 1928 New York Court of Appeals case of Meinhard v. Salmon: ‘[t]he punctilio of an honor most sensitive, is then the standard of behavior.’

Instead, under the SEC’s Proxy Voting Rule of 2003, the investment adviser only needs to execute its delegated voting authority ‘in a manner consistent with the best interest of its client [the investment fund it manages and the fund’s investors] and must not subrogate client interests to its own.’  This broad and ambiguous language has resulted in the SEC rarely using its enforcement power in the area of voting and engagement.    

The SEC must revisit this fiduciary duty language to make it stronger. For example, a fiduciary duty that requires an investment adviser to act solely in the interest of the investment fund and the fund’s beneficial investors and for the exclusive purpose of providing financial benefits. Even if investment advisors claim that their political agenda does provide financial benefits, in an SEC enforcement action, advisors would need to demonstrate that it does.

Such language, combined with an SEC willing to enforce it, would go a long way in helping to control the opportunistic impulses that lead investment advisers to use its voting and engagement power to maximize market share, not the value of the funds that it manages. 

Bernard S. Sharfman is a Research Fellow with the Law & Economics Center at George Mason University’s Antonin Scalia Law School.

This piece abbreviates the extended argument the author makes in their article Opportunism in the Shareholder Voting and Engagement of the ‘Big Three’ Investment Advisers to Index Funds and in their previous post on the OBLB found here.

This post first appeared on Stigler Center's ProMarket blog (here).