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> the less active money there is around, the less accurate our concept of a correct value can be The problem is deeper than that. Active shareholders actually

by kolbe 10y ago

> the less active money there is around, the less accurate our concept of a correct value can be The problem is deeper than that. Active shareholders actually give a shit about corporate governance. Collectively, they put honorable and competent people on the board of directors, and make sensible decisions when other issues are put to shareholder votes. Vanguard and other indexing funds could barely care. Their incentive to care is so small, we may as well call it nothing. Whereas the employees who control these voting blocks at Vanguard can easily make decisions that cause 10,000x more financial impact than their total compensation. And whenever someone is endowed with such power, human behavior throughout our existence has shown most people will be corrupted by it (e.g. see government employees).

marcosdumay 10y ago
Yet, this is a general problem of all kinds of investment funds, not only of index ones. It is a huge problem (and probably responsible for much of the lawlessness we can find on Wall Street), but the switch from active to passive investment shouldn't change a thing.
- kolbe 10y ago
  It's not necessarily active vs passive. It's skin in the game vs no skin. Low fee index funds offer no incentive for the managers to do any actual managing. They follow an equation, and collect a few bps.
  - marcosdumay 10y ago
    Yes, it's not even that simple. It's about having enough skin on the game. No big fund manager has enough skin on the game. That has been true for most of last century and all of the current one, and the expected results are visibly there.
    - kolbe 10y ago
      This is why my push isn't to necessarily increase the active management profession, but instead increase the intelligence of individuals and freedom of necessary information for them to properly manage and understand their own assets. Even if they do just end up choosing to invest in a market cap weighted broad based index, it's important for them to understand how to behave with the management of those assets and to have the ability to manage them (see the distinction versus investing in index funds, because Vanguard's investors do not manage their assets). And if they do not have the requisite intelligence to manage and understand the things they own, maybe they shouldn't own them.
_delirium 10y ago
I'd make that narrower than "active shareholders". The only kinds of active shareholders who can exercise informed and effective oversight are large, professional active shareholders, who buy significant percentages of companies (enough to have a voting share that matters) and have in-house research and legal departments. Many active shareholders don't really look like that. The retail stock-picker buying stocks on ETrade isn't in a position to exercise oversight of the companies they're buying any more than they'd be if they were buying them through index funds. So I don't think much is lost in terms of corporate governance if that group of people moves from stock-picking to index funds. In principle, something could still be lost in the stock price signal if they move to index funds (a different question than corporate governance), although whether retail stock pickers, even taken collectively, are contributing anything useful to the price signal is not necessarily certain.
- nickjarboe 10y ago
  Individuals buying smaller amounts of stocks may not be exercising their votes or have a board member in their back pocket, but they can in the aggregate greatly influence one thing upper management does care about: the stock's price. Unfortunately, if you think management is too focused on the short term, if everybody investing with long horizons buys mutual funds and day traders focus on individual stocks, management is likely to be even more short term focused.
- kolbe 10y ago
  Whether they are mentally capable of making good decisions is another story. But presuming those people exist, then the system should at least be structured in such a way that they're incentivized to use them to properly manage their own assets, rather than in more shifty/nefarious ways. Tell me what you think the result of this scenario might look like. A manager wants to conduct an LBO that grossly undervalues a stock. He couldn't get the votes from shareholders if they were paying attention, but instead he walks up to management at Blackrock, Vanguard and State Steet, and offers the people in charge of voting a very lucrative job at the new private company. How do you think they'll vote?
  - 10y ago
gech 10y ago
> Collectively, they put honorable and competent people on the board of directors, and make sensible decisions when other issues are put to shareholder votes. I don't believe this. They bring in axemen to cut jobs for a bump in stock price. For one, why do they allow for huge severance packages even when they fail?
KKKKkkkk1 10y ago
Talking about honorable and competent people on the board of directors. I recently realized that Apple's board of directors includes Al Gore. He's certainly a honorable man, but what does he know about making and selling iPhones? Why is he on Apple's board of directors?
- fictioncircle 10y ago
  > Talking about honorable and competent people on the board of directors. I recently realized that Apple's board of directors includes Al Gore. He's certainly a honorable man, but what does he know about making and selling iPhones? Why is he on Apple's board of directors? His job isn't to make and sell cell phones. His primary function is to make the C-suite accountable to shareholders. The C-suite's job is to make and sell cell phones. Frankly, Boards function mostly on business metrics and people skills that are generic to any business.
  - ralfd 10y ago
    Al Gores real job on the Apples board had been to have Steve Jobs back. Jobs wanted a card blanche to lead Apple (and never be fired again) so he picked a respectable board loyal/friendly to him.
- dagw 10y ago
  Why is he on Apple's board of directors? He has a working knowledge of how governments operate, and as such knows the right person to call and the right procedure to follow to get stuff done. He probably also still knows a bunch of people whom could be useful to know if you're operating a huge multinational company.
- deleted 10y ago
  [deleted]
- The3rdMan 10y ago
  Al Gore is an "honorable man"?! He is nothing more than a charlatan, dictating to us peons how we should live our lives and reduce our "carbon footprint", while jet-setting around the world in private planes. The man has emitted more carbon dioxide than I can ever hope to do within twenty lifetimes. Politicians are rarely the sort of people you want to proclaim as “honorable”, as by the very nature of their business, they typically sell themselves out like a cheap whores.
Paul-ish 10y ago
Some researchers have looked at the effect of passive investors on corporate governance[1] : > Still, these funds retain the power of voice, the ability to exert shareholder influence on management and governance-related proposals. But critics say passively invested funds, with their lower fees, lack the resources and often the will to monitor their large and diverse portfolios. The Economist calls them “lazy investors.”... > My fellow researchers and I set out to test that claim. In our forthcoming research paper in The Journal of Financial Economics, we show that passive institutions do indeed positively shape firms’ governance policies. Our findings run contrary to the presumption that passive investors lack the willingness and ability to influence firms’ policy choices. > The results of our analysis suggests that passive investors affect firm governance in several ways. For example, we found that an increase in passive ownership is associated with a statistically significant increase in the share of independent directors on firms’ boards. In addition, firms with higher passive investor ownership were more likely to remove firm takeover defenses (for example, so-called “poison pills” and limitations on shareholders calling special board meetings). They were also less likely to have the unequal voting rights of a dual-class share structure. [1] https://hbr.org/2016/05/research-index-funds-are-improving-corporate-governance https://hbr.org/2016/05/research-index-funds-are-improving-c...
- kolbe 10y ago
  I don't know how to say this, but I would trust a common sense understanding of human behavior over research. If there's one rule in life, it's that high finance will exploit legal and immoral loopholes to accumulate wealth, and there is plenty of opportunity for that here, despite the rigorous academic studies done by an institution that is highly connected to the people who can profit off of it.
  - cowsandmilk 10y ago
    You claim that Vanguard doesn't care about corporate governance, but that doesn't match their voting record. For instance, at the 2016 Alphabet meeting, they voted for Alphabet shareholders having one vote per share and adoption of a majority vote for election of the board. Those are the very core corporate governance oddities that Alphabet is using to allow the founders and Eric Schmidt to have total control of the company and Vanguard voted their shares towards better governance. Obviously, since Eric Schmidt and the founders have the majority of the votes, these didn't pass, but they voted the way you would have liked and against management.
bluGill 10y ago
Actually Vanguard claims they care more: active investors will get out if things go bad - they might even make decisions that are good short term bad long term. Vanguard is in for the long term so they care more. One of the things Vanguard can do is ensure good management is in place.
- jalopy 10y ago
  But then that would be active management. This is something Vanguard expressly does not do.
  - wbl 10y ago
    They don't do active fund management AKA stockpicking. The sure do care about making sure management doesn't have it's hand in the till.
  - sigstoat 10y ago
    That's not what active management is. "We believe that our active engagement demonstrates that passive investors don’t need to be passive owners." https://about.vanguard.com/vanguard-proxy-voting/ https://about.vanguard.com/vanguard-proxy-voting/
    - jessriedel 10y ago
      To clarify for other: the distinction is between (1) active choice of what stocks to buy and (2) active voting as a shareholder.
  - jalopy 10y ago
    By "active management" I mean actively taking a role in shaping company management, board makeup, corporate governance, say on pay, etc. While Vanguard may vote all their shareholder proxies, they almost always vote along with the recommendations of management - practically never holding management accountable. Proof: Take a look at their actual voting record on the S&P 500 fund https://about.vanguard.com/vanguard-proxy-voting/supporting-files/proxyvote0040.pdf?v=1472654330804 https://about.vanguard.com/vanguard-proxy-voting/supporting-...

by kolbe 10y ago

marcosdumay 10y ago

Yet, this is a general problem of all kinds of investment funds, not only of index ones. It is a huge problem (and probably responsible for much of the lawlessness we can find on Wall Street), but the switch from active to passive investment shouldn't change a thing.

kolbe 10y ago
It's not necessarily active vs passive. It's skin in the game vs no skin. Low fee index funds offer no incentive for the managers to do any actual managing. They follow an equation, and collect a few bps.
- marcosdumay 10y ago
  Yes, it's not even that simple. It's about having enough skin on the game. No big fund manager has enough skin on the game. That has been true for most of last century and all of the current one, and the expected results are visibly there.
  - kolbe 10y ago
    This is why my push isn't to necessarily increase the active management profession, but instead increase the intelligence of individuals and freedom of necessary information for them to properly manage and understand their own assets. Even if they do just end up choosing to invest in a market cap weighted broad based index, it's important for them to understand how to behave with the management of those assets and to have the ability to manage them (see the distinction versus investing in index funds, because Vanguard's investors do not manage their assets). And if they do not have the requisite intelligence to manage and understand the things they own, maybe they shouldn't own them.

_delirium 10y ago

I'd make that narrower than "active shareholders". The only kinds of active shareholders who can exercise informed and effective oversight are large, professional active shareholders, who buy significant percentages of companies (enough to have a voting share that matters) and have in-house research and legal departments. Many active shareholders don't really look like that. The retail stock-picker buying stocks on ETrade isn't in a position to exercise oversight of the companies they're buying any more than they'd be if they were buying them through index funds. So I don't think much is lost in terms of corporate governance if that group of people moves from stock-picking to index funds. In principle, something could still be lost in the stock price signal if they move to index funds (a different question than corporate governance), although whether retail stock pickers, even taken collectively, are contributing anything useful to the price signal is not necessarily certain.

nickjarboe 10y ago
Individuals buying smaller amounts of stocks may not be exercising their votes or have a board member in their back pocket, but they can in the aggregate greatly influence one thing upper management does care about: the stock's price. Unfortunately, if you think management is too focused on the short term, if everybody investing with long horizons buys mutual funds and day traders focus on individual stocks, management is likely to be even more short term focused.
kolbe 10y ago
Whether they are mentally capable of making good decisions is another story. But presuming those people exist, then the system should at least be structured in such a way that they're incentivized to use them to properly manage their own assets, rather than in more shifty/nefarious ways. Tell me what you think the result of this scenario might look like. A manager wants to conduct an LBO that grossly undervalues a stock. He couldn't get the votes from shareholders if they were paying attention, but instead he walks up to management at Blackrock, Vanguard and State Steet, and offers the people in charge of voting a very lucrative job at the new private company. How do you think they'll vote?
- 10y ago

gech 10y ago

> Collectively, they put honorable and competent people on the board of directors, and make sensible decisions when other issues are put to shareholder votes. I don't believe this. They bring in axemen to cut jobs for a bump in stock price. For one, why do they allow for huge severance packages even when they fail?

KKKKkkkk1 10y ago

Talking about honorable and competent people on the board of directors. I recently realized that Apple's board of directors includes Al Gore. He's certainly a honorable man, but what does he know about making and selling iPhones? Why is he on Apple's board of directors?

fictioncircle 10y ago
> Talking about honorable and competent people on the board of directors. I recently realized that Apple's board of directors includes Al Gore. He's certainly a honorable man, but what does he know about making and selling iPhones? Why is he on Apple's board of directors? His job isn't to make and sell cell phones. His primary function is to make the C-suite accountable to shareholders. The C-suite's job is to make and sell cell phones. Frankly, Boards function mostly on business metrics and people skills that are generic to any business.
- ralfd 10y ago
  Al Gores real job on the Apples board had been to have Steve Jobs back. Jobs wanted a card blanche to lead Apple (and never be fired again) so he picked a respectable board loyal/friendly to him.
dagw 10y ago
Why is he on Apple's board of directors? He has a working knowledge of how governments operate, and as such knows the right person to call and the right procedure to follow to get stuff done. He probably also still knows a bunch of people whom could be useful to know if you're operating a huge multinational company.
deleted 10y ago
[deleted]
The3rdMan 10y ago
Al Gore is an "honorable man"?! He is nothing more than a charlatan, dictating to us peons how we should live our lives and reduce our "carbon footprint", while jet-setting around the world in private planes. The man has emitted more carbon dioxide than I can ever hope to do within twenty lifetimes. Politicians are rarely the sort of people you want to proclaim as “honorable”, as by the very nature of their business, they typically sell themselves out like a cheap whores.

Paul-ish 10y ago

Some researchers have looked at the effect of passive investors on corporate governance[1] : > Still, these funds retain the power of voice, the ability to exert shareholder influence on management and governance-related proposals. But critics say passively invested funds, with their lower fees, lack the resources and often the will to monitor their large and diverse portfolios. The Economist calls them “lazy investors.”... > My fellow researchers and I set out to test that claim. In our forthcoming research paper in The Journal of Financial Economics, we show that passive institutions do indeed positively shape firms’ governance policies. Our findings run contrary to the presumption that passive investors lack the willingness and ability to influence firms’ policy choices. > The results of our analysis suggests that passive investors affect firm governance in several ways. For example, we found that an increase in passive ownership is associated with a statistically significant increase in the share of independent directors on firms’ boards. In addition, firms with higher passive investor ownership were more likely to remove firm takeover defenses (for example, so-called “poison pills” and limitations on shareholders calling special board meetings). They were also less likely to have the unequal voting rights of a dual-class share structure. [1] https://hbr.org/2016/05/research-index-funds-are-improving-corporate-governance https://hbr.org/2016/05/research-index-funds-are-improving-c...

kolbe 10y ago
I don't know how to say this, but I would trust a common sense understanding of human behavior over research. If there's one rule in life, it's that high finance will exploit legal and immoral loopholes to accumulate wealth, and there is plenty of opportunity for that here, despite the rigorous academic studies done by an institution that is highly connected to the people who can profit off of it.
- cowsandmilk 10y ago
  You claim that Vanguard doesn't care about corporate governance, but that doesn't match their voting record. For instance, at the 2016 Alphabet meeting, they voted for Alphabet shareholders having one vote per share and adoption of a majority vote for election of the board. Those are the very core corporate governance oddities that Alphabet is using to allow the founders and Eric Schmidt to have total control of the company and Vanguard voted their shares towards better governance. Obviously, since Eric Schmidt and the founders have the majority of the votes, these didn't pass, but they voted the way you would have liked and against management.

bluGill 10y ago

Actually Vanguard claims they care more: active investors will get out if things go bad - they might even make decisions that are good short term bad long term. Vanguard is in for the long term so they care more. One of the things Vanguard can do is ensure good management is in place.

jalopy 10y ago
But then that would be active management. This is something Vanguard expressly does not do.
- wbl 10y ago
  They don't do active fund management AKA stockpicking. The sure do care about making sure management doesn't have it's hand in the till.
- sigstoat 10y ago
  That's not what active management is. "We believe that our active engagement demonstrates that passive investors don’t need to be passive owners." https://about.vanguard.com/vanguard-proxy-voting/ https://about.vanguard.com/vanguard-proxy-voting/
  - jessriedel 10y ago
    To clarify for other: the distinction is between (1) active choice of what stocks to buy and (2) active voting as a shareholder.
- jalopy 10y ago
  By "active management" I mean actively taking a role in shaping company management, board makeup, corporate governance, say on pay, etc. While Vanguard may vote all their shareholder proxies, they almost always vote along with the recommendations of management - practically never holding management accountable. Proof: Take a look at their actual voting record on the S&P 500 fund https://about.vanguard.com/vanguard-proxy-voting/supporting-files/proxyvote0040.pdf?v=1472654330804 https://about.vanguard.com/vanguard-proxy-voting/supporting-...