BlackRock CEO Larry Fink last week threw down the gauntlet to Wall Street, pledging that the world’s largest asset manager will lead the way in shareholder activism and demand climate change and environmental risk analysis from corporate America.

How will its fiercest competitor, Vanguard, respond? By sticking to its current strategy.

“We’ve been very clear and transparent on climate issues and our approach,” said Vanguard spokesperson Alyssa Thornton.

“Vanguard has and will continue to address climate change risk and advocate for transparent disclosure on climate-related matters through our company engagements and industry advocacy efforts,” said Thornton. She referred investors to the firm’s 2019 stewardship report, available on Vanguard’s website.

Vanguard currently manages $6 trillion in assets — $5.2 trillion excluding money market funds — just behind No. 1 BlackRock, best known for its iShares exchange-traded index funds, with $7 trillion under management. The No. 3 index fund manager, State Street Corp., manages $2.9 trillion. These three firms together hold about 80% of all indexed money, according to Bloomberg data. The combined Schwab-TD Ameritrade would have $5.1 trillion, assuming the merger goes through.

Vanguard currently manages $6 trillion in assets — $5.2 trillion excluding money market funds — just behind No. 1 BlackRock, best known for its iShares exchange-traded index funds, with $7 trillion under management. The No. 3 index fund manager, State Street Corp., manages $2.9 trillion. These three firms together hold about 80% of all indexed money.

In the short term, Vanguard may offer more ESG — or environmental-social-governance — investment funds that appeal to investors with a climate-conscious bent.

“This could push Vanguard to launch more ESG funds, though that trend is already in place, as three out of the last six new funds and exchange-traded funds at Vanguard were ESG-oriented,” according to Jeffrey DeMaso, research director for the Independent Adviser for Vanguard Investors newsletter.

“We have said in the past that an ESG bond fund would be the next” possible offering, DeMaso said. “That would pave the way for Vanguard to launch ESG versions of their Target Retirement Funds.”

The driving force will be investor demand. For all the hype about the rise of ESG, investors have not poured money into these funds. Vanguard’s Social Index Fund had its best year for net inflows of $1.4 billion in 2019, but that still trails well behind the $12.5 billion that went to Vanguard’s Total Stock Market Index Fund.

Vanguard’s new ESG offerings took in a combined $1.2 billion in 2019, into Global ESG Select Stock, ESG U.S. Stock ETF, and ESG International Stock ETF. Overall, ESG-oriented funds only counted for 1.2% of Vanguard’s net inflows last year. That’s up from 0.4% of Vanguard’s flows in 2018, DeMaso estimated.

Big Three

BlackRock’s pledge also shines a light on the massive concentration of ownership among index fund giants — in particular, the “Big Three” BlackRock, Vanguard, and State Street.

“The common ownership of the Big Three is an unintended consequence of the success of index funds. It’s a hard one to unravel as index funds — really, low-cost funds — have been a clear benefit to shareholders. A lot of the concerns raised about common ownership are harder to see, prove, and solve,” DeMaso said.

Just before he died in January 2019, Vanguard founder John C. Bogle — the founder of index investing — warned that index funds were so successful that these could one day effectively control the U.S. stock market, as he wrote in the Wall Street Journal.

“I do not believe that such concentration would serve the national interest,” Bogle wrote in his op-ed.

The Big Three “present a very serious problem because of the power they wield through their ownership,” agreed Bruce Freed, president of the Center for Political Accountability, which focuses on corporate political disclosure.

“Only now is BlackRock moving on climate change, but it remains to be seen what that really means,” Freed said. “It will put pressure on Vanguard, Fidelity, and Charles Schwab."

Schwab currently has $3.94 trillion in client assets, and once merged with TD Ameritrade, would hit $5.1 trillion. A Schwab spokesperson declined to comment on BlackRock, saying “many clients want their investments to align with their values, and we know those values are unique to every individual. We believe it’s important for Schwab to provide investors with access to a broad range of ESG-oriented products, as well as the guidance and tools to use them appropriately.”

“We have found that companies undercut their position on issues like climate change through their political spending. BlackRock has not budged from its voting against” shareholder resolutions demanding transparency on political donations, Freed noted.

Vanguard founder John "Jack" C. Bogle signs copies of his book at the 2017 Bogleheads conference at the Desmond Hotel in Philadelphia. He wrote just before his death about his worry that index fund ownership of the stock market was too concentrated. (Credit: Bogleheads.org).
Bogleheads.org
Vanguard founder John "Jack" C. Bogle signs copies of his book at the 2017 Bogleheads conference at the Desmond Hotel in Philadelphia. He wrote just before his death about his worry that index fund ownership of the stock market was too concentrated. (Credit: Bogleheads.org).

Follow through

Do environmentalists believe BlackRock will act on CEO Fink’s pledge?

“Voting against management and boards would be very significant — and I’d say it’s very much up in the air whether BlackRock is actually going to start putting their votes where their mouth is on a meaningful basis,” said Patrick McCully, climate and energy program director at the Rainforest Action Network in San Francisco.

“BlackRock still needs to go much, much further on divestment to live up to its potential to push companies to aligning on Paris and 1.5 degrees,” considered the danger line for warming, he said, for example, divesting from companies planning to expand fossil fuels and from companies planning new coal plants or tar sand mines or oil pipelines.

He’d like BlackRock to “tell all fossil fuel companies that they will divest if they foot-drag on coming up with long-term zero-carbon plans. So there is plenty of room for others to announce these types of measures and so steal the mantle of ‘greenest mega-money manager’ that [BlackRock’s] Fink has given himself,” McCully said.

In 2019 reports, both BlackRock and Vanguard highlighted the importance of disclosure in relation to climate risks.

However, BlackRock and Vanguard aren’t acting to ensure that those risks are disclosed, managed, and mitigated through strategy and planning that aligns with global carbon targets, according to Majority Action’s 2019 “Climate in the Boardroom” report.

In its 2019 engagement report, Vanguard “goes so far as to disavow direct intervention at companies in relation to the material risks caused by climate change. Vanguard asserts that instead of engaging directly on specific climate strategy and outcomes, it seeks to promote ‘robust board oversight and meaningful company disclosure.’ This approach is belied by Vanguard’s voting record in 2019, when it voted against governance reforms at the full range of oil and gas and utility companies surveyed in this report,” Majority Action alleges.

BlackRock's and Vanguard’s holdings are so significant that at least 16 critical climate votes would have received majority support if both asset managers had voted in favor. Instead, BlackRock and Vanguard voted against them and they failed to pass, according to Majority Action.
Majority Action / Majority Action
BlackRock's and Vanguard’s holdings are so significant that at least 16 critical climate votes would have received majority support if both asset managers had voted in favor. Instead, BlackRock and Vanguard voted against them and they failed to pass, according to Majority Action.

Too big?

Bogle’s worry about market concentration had been on his mind for a few years. In 2017 at the CFA Institute’s convention in Philadelphia, he spelled out his thoughts on the increasing power of index funds since the great financial crisis.

Bogle noted that since 2007, equity index mutual funds enjoyed capital inflows of $1.8 trillion over the ensuing 10 years while their actively managed counterparts were hit with $800 billion of capital outflows.

“Index fund management is heavily concentrated among three giant, trillion-dollar money managers that together hold some 20% of U.S. stocks. That concentration is concerning to me,” he told the CFA crowd. Those three firms — Blackrock, Vanguard, and State Street — at that point owned about 21% of the indexing market.

By founding Vanguard, “I didn’t intend to create a colossus,” Bogle continued, but he should have realized that investors would take advantage of a great deal.

“Passive investing is here to stay. Will indexing ever get to 50% of the market? Maybe, but that could take 10 to 15 years. And we’ll never get to 75%,” he said.

Not every Wall Streeter thinks concentration is a problem among index fund firms. Moreover, BlackRock may simply be virtue-signaling and have no plans for concrete action.

Larry Fink’s climate change messages “sound good to many investors. More important, however, is that Larry remains focused on his most important constituent, which is investors. What sounds good is not always good. Larry needs to continue being a good steward of shareholder capital in order to sustain his business," said New Constructs’ CEO David Trainer, a long-time Wall Street equity analyst.

In theory, addressing climate change “could cost him and shareholders lots of money, and, therefore, undermine the viability of the business, in which case he could no longer address climate change,” Trainer said. The “primary responsibility of corporate managers is to maximize shareholder capital so that there are more profits to enrich the community.”