LONDON (Reuters Breakingviews) - Larry Fink undoubtedly wants to be a good capitalist and a good economic citizen. In his annual missives, the BlackRock chief executive exhorts public companies to follow his advice. BlackRock, which manages $6 trillion worth of investments, is large enough to matter to corporate managers. The 2019 letter, published last week, recommends a “commitment to a long-term approach”. Otherwise, companies cannot “effectively serve all ... stakeholders over time – not only shareholders, but also employees, customers, and communities.” Fink is right - but he faces substantial obstacles in getting his message across.
To be fair, he does not limit himself to fine words. BlackRock’s “investment stewardship approach” involves regular talks with companies over long-term concerns, including strategy, purpose, and culture. It is distressing that so many of them seem to need such conversations, but Fink’s 2014 worry that companies were paying too much to shareholders “at the expense of capital investment” is probably still valid. There are, though, at least four problems with Fink’s approach.
First, the rise of passive investing styles decreases the influence of fund managers. Among U.S. equity mutual funds and exchange-traded funds, the proportion of money tracking indexes and the like was 45 percent at the end of 2017, up from less than 5 percent in 1995, according to a working paper from the Federal Reserve Bank of Boston. BlackRock is far ahead of the average, with index and other market-matching funds accounting for 66 percent of its funds under management at the end of 2018.
Investors get a good deal from low fees with these investment vehicles, pioneered by Vanguard whose founder, Jack Bogle, died last week. In effect, such funds give holders a claim on the broad financial performance of the corporate sector. However, they are a poor platform from which to lecture managers, because they are designed to participate in whole markets, not to pick and choose among individual companies.
Since all selling and buying is automatic, the only meaningful signals passive managers can send are votes in proxy battles, and those come along rarely. As far as funding the future goes, passive funds rarely even participate in the sales of new shares on the public market.
Second, even active fund managers can rarely provide much strategic help. The best and brightest at BlackRock and its peers will naturally be assigned to work on extracting the best possible performance from their funds. In the real world, where clients look for good years and quarters, these stars will inevitably spend most of their time thinking about valuation and marketing. Only a little will be left over for worrying about the bigger, long-term picture.
Besides, they have too many companies to worry about. Corporate managers, who have ready access to inside information, often struggle to keep up with all the facets of their own enterprises. Even the fund-management professionals most dedicated to corporate analysis are typically responsible for a dozen companies. Governance specialists usually look at hundreds. The most they can offer is vague prodding, what BlackRock calls “year-round conversation about improving long-term value”.
So-called activist investors, who choose only a few targets and study them carefully, probably do have the skills needed to give wider-ranging counsel. Unfortunately, their advice is generally aimed primarily at short-term share-price appreciation, not a broader, longer-term harvest from the sort of ambitious investments Fink wants to encourage.
Third, shareholders have different goals from other stakeholders. Fink seems persuaded that, in the very long term, shareholders gain more if everyone else is content. For example, mining companies will ultimately earn more if they take care of the physical environment and the communities affected by their mines, because neglect leads to big fines or expropriations.
Such happy coincidences of benefits exist, but many things in the corporate world really are win-lose, not win-win. Even over many generations, lower prices, higher wages and higher taxes on profit are likely to hurt shareholders while helping key stakeholders: customers, employees and governments respectively. Karl Marx may have exaggerated when he described capitalism as nothing but a battle between workers and owners, but he was not entirely wrong.
Finally, neither Fink nor BlackRock’s shareholders would be satisfied with the results of a truly stakeholder-based approach today. In his 2019 letter, Fink writes about political dysfunction and declining trust in institutions. He should have added corporations to the list of suspects. High profitability and ultra-high executive pay are easy targets for left-wing politicians.
Take BlackRock itself. Its 2018 operating-profit margin of 38 percent is hard to describe as client-friendly, especially in comparison to its largest rival, Vanguard, where clients own the funds and gains flow to them rather than to outside equity investors. As for pay, Fink made $26 million in average annual compensation over 2015-2017. Vanguard’s structure at least avoids this contradiction when it, too, advocates a long-term view and consideration of a range of stakeholders.
Whatever his pay grade, Fink is nonetheless doing a public service by encouraging companies to develop and articulate purposes that go beyond maximising profits. That can only help. However, even the wisest fund manager isn’t going to reshape capitalism single-handed. Company boards and bosses need to hold themselves accountable.
- This item has been corrected in paragraph three to make clear that the indicated passive investing market share refers to the total U.S. equity mutual fund and exchange-traded fund market, not to the entire U.S. equity market.
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