Are Investors Being Disenfranchised by Fund Companies?

Most people have no idea how power and control works in corporate America. In a word, it’s complicated. Generally, the biggest owners have the most control. Sometimes, owners like Facebook’s Mark Zuckerberg, structure shares so they never lose control. He does this by issuing shares with no right to vote.

A long time ago most shares of public companies were owned directly by investors and so voting on important matters (called proxy voting) was done by the owners and votes were allocated by ownership.. The more you owned, the more influence you had. Since shares were more or less evenly distributed across the political spectrum companies stayed fairly benign in their political activism and focused on customers and returns to shareholders.

For some time now, investors have increasingly accessed the investment markets through pooled investment vehicles like mutual funds and ETFs. These make great sense from the standpoint of cost and diversification. Investors are also increasingly preferring passive investments such as index funds which mimic popular indexes and don’t employ any judgment as to company behavior or investment potential.

So, because people are buying into funds rather than stocks, many more shares of ownership are no longer registered to Mr. and Mrs. John Q Public. They are registered to giant fund conglomerates such as Vanguard, BlackRock, and State Street who collectively now own a very large percentage of most public companies. So what’s the problem?

Well, in the past these fund companies, who now control the voting power of the shares, rather than the actual owners of the fund, used to profess to be “non-active” owners. That is, they either did not vote the shares or did not seek to actively influence companies. This was linked to their emphasis, in many cases, on being “passive” investors who just buy the index. Investors were reassured that their votes would not harm or unduly influence the companies they own just because they surrendered their voting rights to the fund company through the fund structure.

Somewhere along the way, these fund companies realized that they could use the voting power they had accumulated more actively. You know what they say, power corrupts.

There was just one problem. Unlike their shareholders, the people who ran these companies were not politically balanced and diverse like their fund shareholders. They were overwhelmingly leftists who are now using the accumulated voting power of their investment customers to implement political change that many of their customers would surely not approve of.

How do they do this? Well, they’ve come up with a system of rating the political/social behavior of public companies called environmental, social, and governance (ESG). Though they argue that these ratings are related to positive investment performance, they are mostly measures of political leanings on issues such as abortion, global warming, religeous freedom, the nuclear family, equal racial and gender outcomes, racial and gender quotas on boards, etc… ie the culture war.

There are two problems with this practice. First, does it improve investment outcomes for their shareholders? Since these kinds of scores and social shaming techniques never existed before, we are dubious that pushing political issues improves investment outcomes. In fact, since these political issues tend to offend half the customer base, one could argue that it hurts investment returns. (See Disney and Netflix)

Second, is it fair or ethical to push a political agenda using the voting power of your shareholders without asking them how they feel about it? Akin to voter disenfranchisement in politics, is there a fundamental ethical problem with pushing politics in business when half of your shareholders would not agree with the political agenda? It seems to us that this is fundamentally unethical and unfair.

Should regulators and lawmakers take a look at these issues. Perhaps. Though this may take some time and, given the nature of politics, there may be no real resolution because one side is getting significant political benefit and will fight tooth and nail to keep this advantage. It’s also hard for regular people to understand how corporate power works and nobody is in a hurry to mount an educational campaign to help folks understand.

So, what can investors do to restore their political power and control as far as their investments go? Invest your money with fund companies and advisors who are either apolitical or who promote your particular views. It’s fine for investors to use political influence. Just make sure your money is being used the way you want. If not, use a fund company or advisor who shares your values or own shares directly in companies behaving ethically, according to your philosophical, moral, and ethical views.

Don’t get disenfranchised! Simply vote with your dollars.