December 30, 2024 | Premium Service | Over the holiday, the Federal Deposit Insurance Corporation issued a statement by Director Jonathan McKernan entitled “Monitoring the Passivity of Index Fund Complexes: Vanguard’s New Passivity Agreement.” The notes to Director McKernan’s statement are essential reading for analysts and investors interested in the activities of the “big three” nonbank asset managers described in a 2022 report by the Senate Banking Committee. McKernan notes in a footnote to his statement:
“Although some have conflated the two issues, the question as to how the FDIC monitors the passivity of index fund complexes is distinct from whether the FDIC should amend its existing regulations to require notice to the FDIC under the Change in Bank Control Act when a notice has also been submitted to the Federal Reserve Board. The latter was the objective of a July notice of proposed rulemaking that I opposed… Notably, these index fund complexes generally do not submit notices under the Change in Bank Control Act to either the Federal Reserve Board or the FDIC, and would not have been affected by the July proposal.”
McKernan rightly understood that asset managers are fiduciaries which hold shares for third parties, thus there is no explicit assertion of control. However, because these firms actually hold the shares used in passive investment strategies like ETFs in “street name” and can vote these shares held indirectly on behalf of investors in ETFs, there is a potential for nonbank managers such as Vanguard, BlackRock (BLK) or StateStreet (STT) to exert effective control of insured depository institutions.
Berkshire Hathaway’s Charlie Munger observed in 2022 that “we have a new bunch of emperors, and they’re the people who vote the shares in index funds.” BlackRock, State Street, and Vanguard—are the “Big Three” asset managers that manage most of the largest of these index funds and around $25 trillion in assets. The Republican staff of the Senate Banking Committee noted in a 2022 report:
“[T]he Big Three’s unprecedented stakes in America’s largest companies might not be objectionable if they were truly passive. The Big Three, however, are anything but. Each of these firms proudly uses the voting power gained from their investors’ money to advance liberal social goals known as ESG (environmental, social, and governance) and DEI (diversity, equity, and inclusion). These once benign-sounding concepts are political movements unmoored from financial performance and, perhaps not coincidentally, also popular with corporate C-suites where managers can claim ‘success’ on matters irrelevant to investor returns.”
With the landslide win by President Donald Trump in November, it is a pretty good bet that progressive agenda items such as “ESG” and “DEI” will disappear from the government lexicon in Washington. We may even see legislation prohibiting managers from voting shares without explicit instructions from the beneficial holder, a change that would threaten the passive investment model. But the market power of the Big Three nonbank managers will remain a threat to banks and any other potential competitors. Even if we count the assets under management of every US bank, the AUM of the Big Three nonbank managers of passive strategies is orders of magnitude larger.
Below we review the performance of the largest bank asset managers as we start Q4 2024 earnings next week.
The Top Bank Asset Managers