Investors' growing disdain for actively managed mutual funds has produced a disturbing consequence: Ownership of American public companies is increasingly concentrated in the hands of just four giant index-fund managers.
Through the end of 2003, the world's four largest index-fund firms --
, Fidelity Management and Vanguard Group -- in aggregate held an average of 12.6% of the 20 largest U.S. companies on behalf of their clients.
Together, for instance, this elite band owns 15% of
, 15% of
and 14.5% of
Johnson & Johnson
Barclays, a British bank, has emerged as the first among near-equals. It has paired its new iShares exchange-traded funds business with its long-established pension fund indexing business to become one of the largest single holders of U.S. companies, if not
largest -- about $1 trillion worth. Fourteen of the 20 largest U.S. public companies now count Barclays as their largest institutional owner.
What Happened to Shareholders' Rights?
The concentration of ownership has unsettling implications for the corporate governance issues now grabbing investors' attention. Consider the recent shareholder vote over the chairmanship at
, which counts Barclays as its top institutional investor, with a 3.5% stake.
Unlike large, U.S.-based shareholders such as the New York and California state pension funds, which held relatively meager positions in the stock, Barclays has refused to publicly reveal its vote on the Disney chairman, or any other matters. "We don't discuss how we vote before or afterward," said Barclays Global Investors spokeswoman Christine Hudacko.
Barclays Global Investors is a San Francisco-based subsidiary of Barclays, a $60 billion international financial-services group based in London. BGI manages $1 trillion in assets in 2,000 funds, about 70% of which is held in funds that mimic the return of broad market indexes such as the
, the Russell 1000 and the Russell 2000. Hudacko said BGI has a proxy committee that determines how to vote on governance issues on behalf of its pension plan or iShares shareholders, but does not canvas those shareholders for their opinions.
The recent vote in Philadelphia on the chairmanship of Disney offers unusual insight. You had an imperial chief executive, a board of directors that has been asleep at the switch, big blocks of shareholders captive to management and voting rules that do not permit a "no" vote -- only a "withheld" vote.
And now we learn that the largest shareholder, Barclays, does not even feel obligated to tell its own clients how it voted. The situation reveals that shareholders' rights are a thin veneer on top of business as usual.
Outsourcing Corporate Governance
If the trend toward shifting investment funds from expensive, actively managed accounts to inexpensive, "passively" managed accounts continues, in a relatively short time the four large indexers could own (on behalf of their clients) more than 30% of most major U.S. companies. That would give a small group of proxy voters unprecedented power in shaping American corporate life. And when you consider the increasing role played by the aggressive team at Barclays, you could almost suggest that the trend toward indexing has led Americans to blindly, unexpectedly outsource a large measure of its corporate governance to the British.
Yet, nationalistic pride aside, that might not be such a bad thing.
Stephen M. Davis, publisher of an international corporate governance report called
Global Proxy Watch
, said Barclays actually has a better-than-average record on corporate governance. "They are very proactive and have extensive guidelines to manage conflicts of interest," he said.
Few major funds have ever disclosed to their shareholders how they vote their shares in proxy battles. And this culture of keeping votes private between the fund and the company has been a major contributor to corporate misbehavior. Fidelity has long professed to have high standards on corporate governance, but it has never revealed its proxy votes to show how it held to those standards. And Vanguard, which also has articulated high standards for the governance of companies in which it invests, has likewise fought disclosure rules tooth and nail.
Starting in August of this year, the indexers will no longer be able to hide their votes, as a
Securities and Exchange Commission
rule will go into effect requiring all fund managers to reveal both their proxy-vote policies as well as their actual proxy votes cast. Hudacko said Barclays plans to set up a page at its Web site in August declaring its proxy positions.
Nell Minow, editor of The Corporate Library, an independent research firm specializing in corporate governance, said large fund managers such as Barclays have had a very good reason for remaining silent on their votes until now: "They don't want to alienate their current or potential clients," she said, noting that every large company is currently, or could potentially become, a customer for its pension fund management services.
Minow said index-fund managers' eleventh-hour conversion to proxy-vote disclosure will ultimately cast Barclays in a good light, however. She says that aside from their obvious conflict of interest, index funds are inclined by their nature to vote for the long-term interests of companies.
"Barclays has always been a very good, very principled owner," she said. "They act in accordance with the strictest standards of fiduciaries. They can't trade out of these companies if they're dismayed, so the only thing they can do is be vigilant about shareholder rights."
Make Yourself Heard
If you're an index fund holder and want more of a say in how the funds' shares are voted, you could become a shareholder of Barclays and State Street and vote on
proxies. At the moment, that might not be such a bad idea. Barclays, at least, appears to be modestly undervalued and pays a 1.1% dividend.
The company's 2003 earnings report was sound, and while the iShares business is one of the sexiest elements of its story from this side of the pond, it's by no means a high-margin or wildly profitable business. British analysts were more apt to highlight the company's accretive acquisitions, its credit card and private-client business, as well as its success at controlling costs.
Shares have appreciated 55% since January 2000, which is much better than the S&P 500's return of -22%. And yet, though analysts expect 8% to 10% growth next year, Barclays trades for a forward P/E multiple of only 11.
The trend toward consolidation of stock ownership might be problematic from a public policy point of view, but there's no reason you can't make a buck off it by buying Barclays at around $37.25 for a long-term hold while you're fingering your worry beads.
Jon D. Markman is publisher of
StockTactics Advisor, an independent weekly investment newsletter, as well as senior strategist and portfolio manager at Pinnacle Investment Advisors. While he cannot provide personalized investment advice or recommendations, he welcomes column critiques and comments at
email@example.com. At the time of publication, Markman had positions in the following securities mentioned in this column: Intel, Cisco Systems, Microsoft, ExxonMobil and General Electric.