Big Index Funds Spend Your Money To Appear 'Socially Conscious'

Collectively, the two behemoths of the passive investment industry, Vanguard and BlackRock, control more than $10 trillion of other people’s money. Why? Because from multi-billion-dollar pension funds all the way down to individual retail investors with 401(k)s like me, they’re trusted to do right by their clients; to maximize the value of their investments.

It appears we have may misplaced that trust. This isn’t about bad bets on underperforming stocks or high fees. It’s about something far more insidious; spending their clients’ savings to improve their own public image.

When these funds aggressively push companies to make expensive but largely meaningless declarations about environmental and social issues, stock values don’t go up and shareholders don’t profit. The only beneficiaries are the funds themselves.

Vanguard and BlackRock get to declare publicly that they are on the right side of history. They get to buy goodwill for the day when the court of public opinion potentially turns on them. It’s a smart PR move. But using their clients’ money to buy that goodwill is also a breach of fiduciary responsibility and financial ethics.

And that’s effectively what these “corporate governance” proposals are. Anecdotal evidence suggests that corporate managers spend upwards of $150,000 per measure. Given that the largest companies typically face 15 or more proposals each year, that equates to more than $2 million worth of valuable time diverted from management’s core fiduciary responsibility to maximize shareholder value. Despite this evidence, more and more proposals crop up every year promoting social positions that have little to no relevance to a company’s performance.

“Passive” investment is the key phrase here. The reason so many people and organizations turn to Vanguard and BlackRock is that their fees are low; a result of an investment strategy that maintains a cross section of the entire stock market without actively selecting any stocks.

Crucial, since their only goal is to minimize costs and track the performance of the general market, they employ almost none of the experts or sophisticated data analysis technology used by active investors.

While that may keep costs to a minimum, it’s also reasonable to question how these companies are suddenly equipped to assess or promote proposals on the companies they hold in their funds. Vanguard, for instance, maintains a staff of 20 to advise them on corporate governance, and these employees are responsible for making complicated and weighty decisions about proposals at thousands of companies.

To remedy this, companies turn to proxy advisory firms like Glass Lewis and Institutional Shareholder Services to provide guidance on which proposals to support.

The issue is that multiple studies have found their advice is not always impartial and doesn’t necessarily benefit shareholders. As far back as 2010 the Securities and Exchange Commission highlighted concerns that "proxy advisory firms may be subject to conflicts of interest or may fail to conduct adequate research and base recommendations on erroneous or incomplete facts." In fact, a study by Stanford economists found that proxy advisory firms were riddled with conflicts of interest and routinely advised companies to implement “best practices” that subsequently reduced shareholder gains by 50-100 percent against companies that declined to act.

Proposals like these are not about disclosure, let alone best practices. They are about public image, social ideals and environmental morality. It’s a false morality, too, that pretends doing good and making a profit are mutually exclusive, when a variety of companies from Starbucks to Home Depot have shown that need not be the case.

If you want to invest your hard-earned money in a firm solely because you think it is going to do good in this world rather than maximize profits, that’s your right. However, Vanguard and BlackRock are not using their money to make these investments, they’re using yours. They’re using money and shareholder votes entrusted to them by everyday people, police and teacher pension funds, other public funds and individual 401(k)s whose owners are largely unaware of these firms’ actions.

It’s past time that passive fund managers were more transparent about the impact of these proposals on returns and gave their members a choice about whether they want to support such measures. With trillions of dollars at stake, the retirement accounts of a whole generation of Main Street investors are at risk. Make your wishes known now by calling Vanguard, Black Rock or your pension advisor. Because this is your money, not theirs.