Giant Asset Managers, the Big Three, and Index Investing

Within the world of corporate governance, there has hardly been a more important recent development than the rise of the Big Three asset managers — Vanguard, State Street Global Advisors, and BlackRock. Due to the popularity of index funds and ETFs, these asset managers now represent some of the largest owners of U.S. public companies.  And because of their size and influence on corporate governance, a robust scholarly literature has identified the promises and perils of Big Three ownership. In a new book chapter, we identify a series of proxies, or shorthand terms, that first appeared in the foundational works in this literature and have become commonplace in both scholarly articles and the financial press. We further show how this shorthand can contribute to misperceptions and confusion.

The first shorthand is the use of the term “Big Three” to refer to three distinct asset managers. Each of the Big Three manages vast amounts of money in indexed products — amounts that have grown dramatically thanks to the rising popularity of index-based investing. However, there are important differences among the asset managers, both in terms of the composition of the assets they manage and their own institutional structures and operations (and our chapter describes these differences in detail). As such, it does not always make sense to lump these institutions together. The focus on them has also limited scholarly focus in important ways. For example, the term Big Three excludes Fidelity, even though it is larger than State Street in terms of assets under management and has also benefitted from a steady inflow of investor funds over the past several years.

The second shorthand is to equate the Big Three with passive funds. This misperception is widespread, with many papers — including prior work by one of us — studying the Big Three’s governance practices to better understand the incentives of passive fund managers. Although this shorthand can be useful under certain circumstances, we show that it has important limitations. After all, each of the Big Three also manages large amounts of active money, and the index funds that they offer are themselves far from homogenous.

This brings us to the final shorthand — the idea that index funds are all passive and interchangeable. We explore the limitations of this shorthand by showing that the concept of passive investing is under-theorized and that there is ample diversity across index funds. In other words, just as there are closet indexers, or active funds that are really quite passive, index funds vary dramatically in terms of the discretion that is awarded to — and used by — portfolio managers, the fees that are levied, and the trading strategy that is used. As such, the active/passive dichotomy that is used both by scholars and portfolio managers to market their mutual funds obscures important features of this market.

The final section of our chapter discusses the implications of these observations for future scholarship. Taken together, they shed light on conversations about how the rise of passive investing affects corporate governance. Beyond scholarly relevance, these observations matter for policymakers seeking to respond to these market developments with legislation. For example, the INDEX Act, a bill recently introduced in the U.S. Senate, would require investment advisers to pass through the votes of “passively managed funds,” defined as any fund that tracks an index or discloses that it is a passive fund or index fund. As we show, this definition sweeps “closet active” funds under its umbrella.

Our analysis also sheds light on other pressing corporate governance conversations and, in particular, those about the growth and appropriate role of large asset managers. We chart these implications in further detail and highlight questions for future research.

This post comes to us from Professor Dorothy S. Lund at USC Gould School of Law and Adriana Z. Robertson, the Donald N. Pritzker Professor of Business Law at the University of Chicago Law School. It is based on their new book chapter, “Giant Asset Managers, the Big Three, and Index Investing,” available here. A version of this post appeared on the Oxford Business Law Blog, here.