Index fund investing has swept the world. In December, for the first time, U.S. investors entrusted more money to index funds than actively managed funds, in which a manager picks stocks or bonds for you.
There’s a good reason for the index funds’ popularity. For most people, owning a little piece of the entire market, which you can do at low cost with an index fund, has been more profitable than buying and selling securities, either on their own or through a manager.
But the relentless growth of index funds has come at a cost. One significant problem is that the most diversified funds own shares in every publicly traded company in the market, and if you don’t like a company, or its specific policies, you’re stuck. You couldn’t even exercise your vote on issues you thought were important because until recently, the fund managers insisted on doing that for you.
Well, that’s been changing in a big way.
BlackRock announced this month that it was expanding an experimental program to give investors six flavors of policy choices — like a focus on climate change or a preference for religious values — in votes on corporate issues. State Street already has a similar program underway, and Vanguard is tiptoeing into this kind of voting choice, too.
All told, the three giant fund companies have given scores of millions of investors, with $4.6 trillion in assets, a way of expressing their views on corporate issues. This is certainly an improvement. And it could eventually lead to profound changes throughout corporate America, even as it eases some ticklish problems for the big index fund companies.
The Problems
In the view of scholars like John Coates, the author of “The Problem of 12: When a Few Financial Institutions Control Everything,” the growth of index funds has had the unintended consequence of diminishing shareholder democracy.
A handful of index fund companies, led by BlackRock, Vanguard and State Street, have become universal owners, Mr. Coates, a Harvard Law professor and former Securities and Exchange Commission official, said in an interview.
“Index funds have too much power,” he said. “They are the biggest shareholders in just about every publicly traded company. And the trend of over-concentration of ownership is continuing.”
Until very recently, index fund executives — not the millions of people who invest in their funds — had all the power to cast votes, or proxies, for fund shareholders. This voting power gave fund executives a potentially decisive voice on crucial matters, like how much a corporate chief executive was paid or whether a company’s business is environmentally responsible or whether it has treated its employees properly.
Three years ago, for example, BlackRock, State Street and Vanguard cast the pivotal votes in a proxy battle at Exxon Mobil, the fossil fuel giant, and helped elect three dissident members to the board of directors with the goal of pushing the energy giant to reduce its carbon footprint.
But the fund companies have become uncomfortable in the public spotlight. They have found themselves embroiled in the culture wars — criticized from the left for failing to sufficiently embrace environmental concerns and from the right for emphasizing them excessively. State Street and BlackRock, among other financial firms, have recently backed away from full-throated commitments to battle climate change, saying that they need to focus even more sharply on their purely financial duties..
Given that context, it’s not entirely shocking that fund companies are beginning to give a substantial degree of proxy voting choice to fund shareholders — and in effect, sharing responsibility for difficult decisions with individual and institutional investors, like pension funds.
Whatever the fund companies’ motivation, the changes in voting choice could shift the alignment of power in the corporate universe.
Voting Choice
What the companies are experimenting with isn’t true “pass-through voting,” which would involve asking millions of fund shareholders how they want to vote in thousands of specific proxy contests each year, and then actually casting those individual votes accordingly.
Instead, the companies are offering investors something simpler and more manageable: broad policy choices.
BlackRock, for example, announced on Feb. 13 that it was offering a “pilot” voting choice project to three million individual investors in a plain vanilla, popular S&P 500 index fund, the iShares Core S&P 500 ETF. (That’s short for exchange-traded fund, an index fund that can be traded all day on a stock exchange.) Many pension funds and other institutions that invest with BlackRock can already cast proxy votes as they wish.
At BlackRock, $2.6 trillion, or half of the firm’s equity index assets, are eligible for what it calls Voting Choice. “Clients with total assets representing $598 billion are using Voting Choice as of Dec. 29, 2023,” the company said in an email. It added, “That amounts to about 25 percent of the total eligible assets.”
State Street has already made $1.9 trillion in assets — more than 80 percent of its total equity index assets — eligible for inclusion in its proxy choice program. That includes a broad range of popular E.T.F.s., though not its biggest S&P 500 E.T.F., known as SPY.
About $250 million worth of fund assets held by individuals, as well as about 10 percent of institutional assets, are being voted according to six different policies, Lori Heinel, chief investment officer at State Street Global Advisors, said in an interview. “We don’t consider what we’re doing an experiment. We’re in the market. It’s available.”
Vanguard, which started the first commercially available index fund, is proceeding more slowly. Six of its funds, with $100 billion in assets, are included in what the company does call an experiment. They are its S&P 500 Growth, Vanguard Russell 1000, ESG U.S. Stock ETF, Mega Cap and Vanguard Dividend Appreciation index fund. This is just a start, the company said in an email.
“We are using our pilot to gather client feedback, refine our approach, and optimize the investor experience as we expand to more funds,” Vanguard said. It says it offers four choices, but two are more like non-choices: Don’t vote at all, or let Vanguard vote for you.
How It Works
What this all means in practical terms is that if you are an eligible shareholder, you can continue to have a fund company make voting decisions for you (or, at Vanguard, withhold your vote). But you now have other options.
If you choose, your votes will be cast based on recommendations from a shareholder advisory service that aligns with a specific policy.
These are the options at BlackRock. Three are advised by Institutional Shareholder Services:
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Socially Responsible Investment (SRI) Policy. It’s explicitly for investors who require companies to behave “in a socially and environmentally responsible manner.”
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Catholic Faith-Based Policy. It also generally requires “socially and environmentally responsible” behavior. But last year, according to BlackRock, this policy opposed an unsuccessful proposal at Coca-Cola asking the company to report on how state abortion restrictions could affect its business.
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Global Board-Aligned Policy. It is what most corporate boards would prefer, with votes “generally aligning” with board recommendations on “environmental and social matters.”
Three policies come from Glass Lewis:
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Benchmark Policy. It includes classic good governance principle. Many proxy votes aren’t binding, but with this policy, boards should act as though they are, responding to shareholder wishes.
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Climate Policy. It holds boards to strict environmental standards. The policy also addresses gender diversity: “If less than 30 percent of the board is female, the Climate Policy will vote against the entire incumbent male nominating committee members for large- and mid-cap companies.”
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Corporate Governance-Focused Policy. It emphasizes “the fiduciary responsibility to drive long-term, economic shareholder value.”
How these policies play out in practical voting isn’t always clear. On many issues, they will certainly produce different outcomes. A proxy vote last year, asking Exxon Mobil to report how workers and communities with plant closings are affected by the transition from fossil fuel, is a case in point.
In an email, BlackRock said, Exxon management, BlackRock’s own policymakers and the Board Aligned policy all opposed the resolution. But the Catholic Faith-Based Policy, the socially responsible investing policy and the Glass Lewis benchmark policy all supported it.
Unlike the proxy battle at Exxon in 2021, this one failed. BlackRock is the third largest shareholder in Exxon, according to FactSet. The only entities with larger stakes are Vanguard and State Street.
This splintering of the immense BlackRock vote may be what Larry Fink, the founder and chief executive of the asset manager, intended when he said, in a letter to the company’s shareholders last year: “There are many people with opinions about how we should manage our clients’ money. But the money doesn’t belong to these people. It’s not ours either. It belongs to our clients, and our responsibility and our duty is to them.”
State Street’s policy choices are similar to BlackRock’s. Vanguard’s two program choices include a “board-aligned policy” and an E.S.G., or climate, policy.
Looking Ahead
How the voting programs will affect votes this corporate proxy season, which is just beginning, is an important question. Lindsey Stewart, director of investment stewardship research at Morningstar, tracks fund company voting patterns closely. He says he can’t tell whether they made much of a difference last year.
Professor Coates says the current voting choice programs are complex, and they may not attract a lot of interest unless the companies find ways of focusing on the most pressing issues each year. He cited perennial battles over labor issues at Starbucks, or major climate issues at fossil fuel companies, or disputes over reproductive rights, as areas that fund companies might highlight. Translating the voting policies into actual votes is important, he said, and needs to be done clearly, ahead of proxy voting.
“I view this as progress, but it’s far from perfect,” Professor Coates said.
Now, at least, there are better prospects for fund shareholders, who were consigned to silence, to at last have a voice.
