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How Passive Fund Giants Are Driving Higher Returns

A pair of research papers suggest that the rise of shareholder activism by firms like BlackRock and State Street could lead to higher performance over the long term.

Passive managers have won assets away from active investors by offering cheaper products and benchmark-meeting performance. Now, they’re using their increasing influence to shape policy at the companies they hold – a trend which researchers suggest could be another competitive advantage for passive giants like BlackRock and State Street.

A research paper this month from the University of Pennsylvania’s Institute for Law and Economics documents the growth of shareholder activism by passive fund sponsors, a trend which authors Jill Fisch, Assaf Hamdani, and Steven Davidoff Solomon argue is demonstrative of passive managers’ ability to compete with active managers by improving long-term investment returns, not just lowering fees.

According to the paper, these firms “exploit their comparative advantages – their size, breadth of portfolio, and resulting economies of scale – to focus on improving corporate governance, efforts that reduce the underperformance and mispricing of portfolio companies.”

Last year, for example, the authors noted that BlackRock had more than 1,600 shareholder engagements, while Vanguard Group reported more than 800. State Street participated in more than 600 engagements, while also sending “hundreds of letters to its portfolio companies.” Such efforts were influential in the success of shareholder proposals like the new climate change disclosures adopted by Exxon Mobil last year.

[II Deep Dive: ExxonMobil Passes Proposal for New Climate Change Report]

“Since passive funds cannot exit their investment in underperforming companies, they have an incentive to ensure that companies in their portfolio are more responsive to shareholder demands, and their growing size gives them the voting power to demand that responsiveness,” Fisch, Hamdani, and Solomon explained. 

This increasing focus on corporate governance has been shown to result in improved performance by portfolio companies. A separate research paper, published last month by professors at St. John’s University, provides evidence that banks and insurance companies perform better when owned by large institutional investors like BlackRock, State Street, and Vanguard.

The findings suggest that some of these firms are “successful in obtaining long-term returns by exerting influence over the management of their invested firms,” according to authors James Barrese, David Pooser, and Ping Wang.

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