One of Warren Buffett’s favorite bits of advice to the average person is for them to invest a dollar amount each month into a passive index tracker fund. The wisdom behind it is simple – the average mutual fund manager under-performs the index and the average person can’t separate the great managers from the poor. Collectively, people can only do as well as the stock market index minus management fees, so it makes sense to minimize the fees.
The advice seems to have finally sunk in, the proportion of assets in passive funds has almost doubled in the last 10 years and now stands at 21% in the USA. That is projected to keep rocketing over the next 10 years.
The movement to passive seems to have its own online army as well, message boards are now full of people that will recommend index funds to all who ask for help investing, and when challenged will link to one of many statistical papers that proves the average investor does better in index funds than actively managed funds. You can’t argue with statistics can you.
We value investors like to think we have what it takes to separate the wheat from the chaff, with individual stocks as well as money managers. But we can never escape the fact that if everyone did as we did, our returns would all be average.
But it is becoming obvious to me, that this liberation of the people from the oppression of greedy fund managers is coming at a cost – to shareholder power and activism. It is one component of what has been a greater shift towards shareholder apathy. An index manager balancing his portfolio does not care about individual holdings, he is not paid to and has no incentive to. As Charlie Munger would say, you can predict how people act and why they act just by looking at the incentives.
And with more shareholders taking little interest in governance, too many boards of directors are sitting comfortably in the knowledge shareholders will have a difficult time trying to mobilize against them.
Many fund managers (both active and passive) these days hire a firm to vote for their shares. These firms are supposed to be experts in directorship and effective management, yet they are all too often more focused on ticking boxes on a checklist and keeping the peace than what is good for shareholders. Have a read of the FMCO annual letter for case in point.
The USA is lucky in that shareholder activism is still alive, though far from thriving. Other countries like the UK have little to no shareholder activists, or what the press would refer to as ‘corporate raiders’, that will prey on the poorly managed companies and stir up the directors.
People may dislike how people like Carl Icahn operate and make money, but roles like his are vital to keeping the market efficient and fair for shareholders.
So consider how much more difficult it is for a shareholder to gather the votes to influence the board when 21% of those votes are with passive managers that do not care and whose votes are dictated by one of the few ‘proxy advisers’. These advisers hold no stock themselves and it isn’t clear whether their fees have any performance related element. They also appear to be particularly averse to confrontation, this quote is from Institutional Shareholder Services, a unit of indexer MSCI
“Negotiations enabled boards to curtail contentious contests at high-profile targets, to repel repeat rows over shareholder resolutions or executive pay, and to dodge very public debates with activists over strategic direction.”
These aren’t the qualities I would hope to see from someone responsible for my votes. When it comes to boards, I don’t want to focus on ‘not making a fuss’, they should follow the wishes of the shareholders – if these are misguided then the board should be able to give a convincing argument why and resolve the issue.
Some boards simply wring the company for everything they can – think Dan Loeb and the Sotheby’s situation. In these cases I don’t want to send in a sheep dog to try and herd the board, I’d rather send in a pit bull terrier.