What, exactly, is the relationship between BlackRock and the retail investors who own shares in the index funds that it manages? This issue came to mind when reading Larry Fink’s 2022 letter to chief executive officers (CEOs). In the letter, he referred to retail investors as clients, but I don’t believe that is the way they are currently being treated.
The relationship between BlackRock and retail investors is somewhat complex. It begins with BlackRock contracting with mutual funds and exchange-traded funds (ETFs) to manage their portfolios. These investment funds are the shareholders. BlackRock’s role is limited to that of adviser. It does not have an economic interest in the underlying securities that are held in portfolios. Moreover, not having an economic interest means that BlackRock has little incentive in becoming informed about the operations of the companies whose stocks make up the portfolios that it manages.
BlackRock does not contract with retail investors. However, the contractual relationship that it does have with index funds creates both an ethical and a legal relationship with these investors. This is the result of BlackRock being entrusted with assets that are beneficially owned by retail investors. This puts BlackRock in the role of fiduciary, with duties to act in the investors’ best interests. It is now obligated to manage in a prudent manner and implement shareholder voting and engagement with a focus on “portfolio primacy.” That is, BlackRock’s management must have the objective of maximizing the value of the entire portfolio of securities at any point. As I discuss in my new writing, such value maximization is the most that BlackRock can assume about the voting and engagement preferences of these millions of retail investors as a class.
As an index fund manager, BlackRock exists in a world of very low management fees. Therefore, to enhance its own profitability, it is continually being tempted to look away from the interests of retail investors and toward its own. These interests include the desire to steer retail investors toward funds that generate higher fees, such as ESG funds. For example, it was recently reportedthat BlackRock has been shifting investors into an ESG index fund, the iShares ESG Aware MSCI USA ETF, by inserting it into BlackRock model portfolios offered to financial advisers. This resulted in the clients of these advisers investing in an index fund with a relatively high fee (0.15%)—five times higher than the fee charged by BlackRock’s plain vanilla iShares Core S&P 500 ETF(0.03%)—without their knowledge.
Other BlackRock interests include attracting millennial investors, even though millennials currently hold only about 2.5% of corporate equities and mutual fund shares, versus 55% for baby boomers; maximizing government support to ward off burdensome regulation, such as in the area of antitrust enforcement; increasing the market share of 401(k) assets held at portfolio companies; and the need to appease its own activist shareholders when deciding how to vote and engage.
These interests can be facilitated by leveraging its huge amount of shareholder voting and engagement power—for example, BlackRock’s support of Engine No. 1 in its recent proxy contest at ExxonMobil. Shockingly, Engine No. 1 never provided specific recommendations on how it wanted the company to accomplish its objectives of increasing the stock price, reducing its carbon footprint, or transitioning it into profitable clean-energy production. The inability to provide specific recommendations must have been a clear indication to BlackRock that Engine No. 1 was not truly informed about the operations of ExxonMobil, and therefore there was no basis for BlackRock to provide support for its activism. Nevertheless, BlackRock used its significant voting power to help elect three of four Engine No. 1 director nominees to the company’s board.
Engine No. 1 was able to get BlackRock’s support by appealing to its desire to be perceived as an investment adviser that is making a difference in mitigating climate change, even though there was no reason to believe that this would be the result of its support. Such a perception was necessary to attract millennial investors and facilitate BlackRock’s marketing strategy.
BlackRock’s use of its voting and engagement power as a tool to enhance its own interests is a dangerous game for it to play. It interferes with the implementation of voting recommendations and decision-making created by the most informed locus of authority in a public company: the board of directors. Most important, this interference is being driven by an uninformed entity with significant voting power seeking to serve its own interests. If this practice is not stopped, it will lead to value-reducing decision-making at portfolio companies, negatively affecting the value of index funds.
To avoid such behavior, retail investors need to demand the right to influence how BlackRock votes—not by giving retail investors the right to vote at all the companies that their index funds may hold, which would probably entail tens of thousands of votes per year, but by giving them the opportunity to participate without spending an overwhelming amount of time on the activity. For example, as I have previously recommended, this could be a simple check-the-box approach on the part of the investor directing the index fund to: 1) abstain from all voting at a portfolio company; 2) vote according to the voting recommendations provided by the portfolio company’s board of directors; or 3) defer to the discretion of the investment adviser. While this will not solve the problem entirely, it would be a good first step in helping BlackRock treat retail investors as clients.
