Jack Bogle championed index funds as a way to democratize investments. Now the three biggest index fund managers pose a new threat, a former Federal Reserve staffer argues.
“Asset management firms have become a part of a new ‘money trust’ — a system of financial architecture dominated by a few large banks, private equity firms, and hedge funds,” Graham Steele, director of the Corporations and Society Initiative at Stanford Graduate School of Business, wrote in a new report expected to be published Tuesday. The working paper is being published by the American Economic Liberties Project, a non-profit focused on antitrust policy.
According to the paper, the stock holdings of BlackRock, Vanguard, and State Street give them “outsized influence” in corporate elections and reward anti-competitive behavior among companies in a given sector. The sheer size and interconnectedness of the three firms influence the stability of the financial system, and they benefit by providing critical infrastructure, such as custody and technology platforms.
Even though BlackRock and the other firms don’t own the underlying assets that they manage, they still control many activities, including voting shares, Steele said. According to the paper, BlackRock, Vanguard, and State Street manage over $15 trillion in global assets, which is equal to approximately three-quarters of the U.S. gross domestic product. The asset management industry has also grown more concentrated over the last decade, with these three firms attracting 82 percent of all investor money over the time period. BlackRock, State Street, and Vanguard also control between 73 percent and 80 percent of the exchange-traded fund market, according to Steele.
That dominance means that when combined, the “Big Three” are the largest shareholder of 88 percent of firms in the S&P 500.
This concentrated ownership has several potential consequences, according to Steele. One example is the rise in stock buybacks. Research from Lucian A. Bebchuk and Scott Hirst has found that companies with a high amount of index fund ownership have increased stock buybacks more rapidly than peers with more diverse ownership.
The largest asset managers also provide related technology and financial services to external firms that further increase their power and influence. BlackRock, for example, has its Aladdin platform, while State Street has its global custody business.
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Ironically, low fees, which benefit investors, have driven much of the concentration in the asset management industry.
“The outsized footprint of a few large financial companies poses new issues for the governance of corporate America, the competitiveness of our economy, the concentration of political power, and the stability of financial markets,” Steele wrote.
Spokespeople for BlackRock, Vanguard, and State Street disputed the paper in separate statements provided to II.
“We fundamentally disagree with the conclusions in this paper,” State Street said. “Index funds provide efficient, low-cost investment access to millions of individual investors who use these investments to fund their retirement and other personal financial goals.”
BlackRock, meanwhile, said the report “contains multiple factual inaccuracies and misconceptions about BlackRock, the asset management industry, investment stewardship and their impact on financial markets and the broader economy.”
“BlackRock welcomes constructive debate about the role of asset managers and the benefits we bring to financial markets and society more broadly,” the firm said. “However, we are concerned about the paper’s call for proposals that would harm investors and companies by upending the value proposition of low-cost investment solutions that benefit millions of people saving for retirement and other financial goals.”
In a separate statement, Vanguard said it has “grown responsibly by focusing on lowering costs for investors, being prudent in our product development, offering only funds that meet an enduring long-term need; and promoting responsible investing.”
“We take our responsibility as stewards of our clients’ investments seriously and are grateful that investors continue to entrust their savings to Vanguard,” the firm added.
In an interview with Institutional Investor, Steele said he had been working on the paper, which pulls together the results of multiple studies, before the pandemic. But the behavior of markets and government actions in March and April, which he documents in the study, offered a real-time example of many of his concerns.
Steele said the solution is to break the “Big Three” up, even though he concedes that is relatively unlikely.
“I wanted to start a conversation, so why not put it out there, then you can tell me other solutions,” said Steele, who previously worked Federal Reserve Bank of San Francisco. He has also served as minority chief counsel for the Senate Committee on Banking, Housing & Urban Affairs.
Steele said Congress has addressed the consolidation of power on Wall Street before, including in the 1930s. In 1968, for example, a house banking committee said the trust operations at banks had an outsize influence on large parts of the economy as a direct result of controlling the voting of large blocks of shares that were owned by institutions like pensions and individuals.
“I think a lot of problems come from the concentration issue and how much of these real economy companies they own,” Steele said. “Regulation can play a role in reducing financial risks. But to me, the idea of breaking up the firms reduces the political power and economic resources of these three big companies.”