Owning 22% of an S&P 500 company is a nice position to be in. Your goal regarding this investment is to maximize “your” company’s profit (maybe while trying to be a good “corporate citizen”) is clear cut. You advocate for and support market and non-market strategies that lead to those ends. It gets more complicated if you own large stakes of two companies with conflicting interests, let’s say, for example, a wind farm and a coal mine. In that case, what is your stance on clean energy subsidies?
Now imagine owning a significant stake in the whole economy, with all the intricate conflicts this includes.What do you do now? Do you try to maximize each company’s profit? Do take a passive stance, vote with management, and don’t intervene? Or do you try to adapt a holistic view and base your decisions on what would be good for your portfolio overall? This is basically the position the biggest three asset managers, BlackRock, State Street, and Fidelity, are in. As of 2021, they collectively own around 22 % of the average S&P 500 company, and they and commentators alike have wondered how best to balance the interests of their portfolio companies and investors.
Research indicated that large index funds have historically taken a predominantly passive stance and largely voted with management, even when it was underperforming. This might be due to fear of harming share prices by rocking the boat or simply a result of the slim fee structure that most funds have, which means that the high cost of active involvement in any company is unlikely to be offset by an increase in fees.
Others, however, have suggested that big asset managers should pursue a different approach due to their unique position. Their concept of “universal ownership” claims that traditional shareholder focused corporate governance models do not sufficiently take into account that large asset managers are uniquely and unavoidably exposed to so called “external risks.” These risks are especially true for climate change, environmental destruction, and social unrest since they effectively own a large stake in the whole economy. A common point of criticism is that asset managers do not factor those risks in sufficiently. For example, a recent report criticized Fidelity for its continued investment in fossil fuel despite the significant risk that climate change poses for their overall portfolio. Larry Fink, CEO of BlackRock, the world’s largest asset manager with over $10 trillion under management, seems to agree that universal challenges pose a risk for BlackRock’s universal portfolio. Starting in 2018, he emphasized to BlackRock’s portfolio companies that corporations have a purpose beyond the maximizing of short term profits and are responsible to their stakeholders, and therefore should incorporate environmental, social, and governance (ESG) matters into their strategy. Mr. Fink has continued to stress this point ever since, although he specifically emphasized the unique importance of capitalism to create social benefit in his latest letter.
The reason for this change in tone might be that the exceptional influence of large asset managers has come under increasing scrutiny in the last few years. Various academics and pundits have publicly worried that universal ownership might lead to anti-competitive behavior or could incentivize asset managers to influence companies in ways that benefit their overall portfolio but hurt the individual company. Furthermore, taking a pro-ESG stance exposes fund managers to criticism from those who disagree with the fundamental idea of stakeholder-capitalism. This critique is multifaceted. On one side of the spectrum are academics who argue that ESG pledges are either greenwashing, a tool underperforming managers can use to entrench themselves, or that measuring performance on ESG-metrics in a reliable way is impossible, even for the best-meaning managers or investors. On the other side are those who see ESG as nothing more than an ideology and who fear that management would use their power as fiduciaries to further personal beliefs. Critics from both angles are especially suspicious when fund managers like Mr. Fink demand that their portfolio companies implement stronger ESG strategies, given the significant leverage asset funds have over vast parts of the economy.
Therefore, asset managers face a dilemma. They always have the option to continue to pursue a traditional, shareholder-focused governance strategy. However, this means potentially harming their fund’s performance in the long term if traditional portfolio strategies turn out to be superior. And in the short-to-medium term, it is likely to upset ESG-minded activist shareholders and potentially alienate the growing number of retail investors for whom a strong ESG-approach is an important factor when deciding where to invest. Or they can demand that their portfolio companies pursue ambitious ESG-goals. This would pose the problem that – absent established measuring standards – quantifying performance on these metrics might be very difficult, harm their fund’s short-term performance, and expose them to the critique of shareholder-primacy investors and ESG-critics.
08Given a choice between two options with mixed prospects, BlackRock is apparently trying to establish a third option that would let the fund escape from this conflict. In 2021, BlackRock announced that it is going to allow large institutional investors, like pensions and endowments, to vote their shares individually on matters linked to that investment. Through this approach, BlackRock could avoid taking a stand in this issue and relocate the decision to its investors. However, it remains so be seen how BlackRock is going to implement this revolutionary feature, since so far there are not many concrete details. One thing, however, seems certain: large asset managers will continue to play an ever more important role in the economy, and it remains to be seen how their growing influence will shape the governance in the future.