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The world's least scary duopoly

Big asset managers aren’t scary. Neither is passive investment.

I say this a lot, but I’m not sure I’ve really spelled it out anywhere, so I thought I’d take the opportunity provided by Bloomberg Markets to explain why the scaremongers are wrongheaded.


Bloomberg, in this piece, has done its best to paint the rise of Blackrock and Vanguard in the scariest possible light. In a story so important that it required four different reporters, we’re presented with a classic parade of horribles, designed to persuade us that the sheer size of these two asset managers is a bad thing, rather than a good thing. It’s a fair assumption that most of the arguments against passive investment are in here somewhere.

So let’s go through the article slowly.

Imagine a world in which two asset managers call the shots

This is how the story begins, and it’s already engaging in deceptive rhetorical devices. The idea behind the article is to ask whether it would be a Bad Thing were the world’s two biggest asset managers to get a lot bigger than they are already. But then, in the very first clause, the authors go ahead and assume the answer to their own question! Such a world, they say, would be one where Vanguard and Blackrock “call the shots”.


That sounds bad. Except it’s not at all clear what the shots in question actually are, nor is it clear how having $20 trillion under management creates a world qualitatively different from the current world, where they already have over $10 trillion. The current world is not bad! At least when it comes to concentration among asset managers. It’s certainly no worse than when these guys had $5 trillion, or $1 trillion. If going from $1 trillion to $10 trillion caused no visible harm, it’s hard to see why going from $10 trillion to $20 trillion would do so.

in which their wealth exceeds current U.S. GDP

Aaaaaargh this is appalling and we’re not even halfway through the first sentence. First, never compare a stock to a flow, everybody at Bloomberg should know that, it’s stupid and lazy and makes readers think that the rest of the article is probably going to be stupid and lazy too.


But also: Blackrock has $6 trillion of assets under management today, a market capitalization of about $80 billion, and a book value of about $30 billion. The “wealth” of a company is not a well-defined term, but insofar as Blackrock has wealth, I’d put it at about $30 billion, which is about 0.5% of $6 trillion, the number Bloomberg is using as its wealth.

Think about it this way: If I get a job managing Mark Zuckerberg’s fortune, does that make me a billionaire? Does that mean my wealth has suddenly shot up to $70 billion? Of course it doesn’t. Blackrock and Vanguard manage other people’s money, which means it’s not their own wealth.

and where almost every hedge fund, government and retiree is a customer.

Again, “customer” is ill-defined here. If a hedge fund hedges its stock picks by going long or short a broad-market ETF, does that make that fund a “customer” of Blackrock or Vanguard? An ETF is a stock listed on the stock market, and there is surely a difference between trading a stock, on the one hand, and being a client of an asset manager, on the other. And, again, what proportion of hedge funds, governments, and retirees are “customers” now, however broadly that term is defined? How much would that proportion rise if the duopoly’s assets were to double? It’s not at all obvious that a world where they manage $20 trillion is really all that different from where we’re at already, and the fact is that of all the scary things in our current world, this particular duopoly is about as benign as they come.


But anyway, here comes the core thesis:

BlackRock Inc. and Vanguard Group — already the world’s largest money managers — are less than a decade from managing a total of $20 trillion, according to Bloomberg News calculations.


“Calculations” is a great word, isn’t it. It sounds so scientific. But of course you can’t calculate what is going to happen in the future. Probably “extrapolations” would be better, since that seems to be what’s going on: they take the rate at which the companies assets have been growing for the past five years, and just extrapolate it indefinitely into the future.

This is silly, for two main reasons. Firstly, if you extrapolate these growth rates far enough, you’ll eventually find yourself in a world where Vanguard and Blackrock both manage more than 100% of the world’s assets. And secondly, by far the biggest factor driving asset growth over the past five years has been the massive bull market in US stocks. If your stocks double in price, then your assets under management double in value, without any inflows at all. And no one believes that the rate at which stocks have been rising over the past five years is likely to continue through 2026. Yet, that would seem to be the basis of Bloomberg’s “calculation”.

Amassing that sum will likely upend the asset management industry, intensify their ownership of the largest U.S. companies and test the twin pillars of market efficiency and corporate governance.


Remember that what we’re talking about here, mostly, is just stocks going up in value. Sure, there’s a certain amount of rotation out of active strategies and into passive as well, no one’s assuming zero inflows. But to a first approximation, the way that Blackrock and Vanguard get to $20 trillion by 2026 is just for stocks to continue to rise. If that happens (which is improbable), then the asset management industry is not going to be upended, and neither will market efficiency or corporate governance be particularly harmed. On the other hand, if stocks don’t continue to rise, or if they fall (as is quite likely, given current frothy valuations), then the chances of Blackrock and Vanguard reaching $20 trillion by 2026 are minimal at best.

Basically, Bloomberg is wrong either way.

None other than Vanguard founder Jack Bogle, widely regarded as the father of the index fund, is raising the prospect that too much money is in too few hands, with BlackRock, Vanguard and State Street Corp. together owning significant stakes in the biggest U.S. companies.

“That’s about 20 percent owned by this oligopoly of three,” Bogle said at a Nov. 28 appearance at the Council on Foreign Relations in New York. “It is too bad that there aren’t more people in the index-fund business.”


You know who has a distressing monopoly when it comes to index funds? S&P Global, which owns the S&P 500 index and which licenses it out, at a rate of about 3bp, to every S&P 500 index fund. I’d love to see that monopoly attacked. But I can’t for the life of me understand why anybody benefits from a world where there are a dozen S&P 500 index funds rather than three. The reason why new entrants can’t compete is that these funds compete on price and liquidity, and you need to be enormous to be able to offer the lowest fees and the most liquid markets. So, there are three players, all of whom are enormous, and all of whom are competing aggressively on price. What would a fourth player add? Or a twelfth? Index funds are fungible commodities where bigger is better. So let’s celebrate size: it means lower fees and higher liquidity.

Vanguard is poised to parlay its $4.7 trillion of assets into more than $10 trillion by 2023, while BlackRock may hit that mark two years later, up from almost $6 trillion today, according to Bloomberg News projections based on the companies’ most recent five-year average annual growth rates in assets. Those gains in part reflect a bull market in stocks that’s driven assets into investment products and may not continue.


“May not” continue? Definitely will not, more like. Not through 2026, anyhow. No bull market has ever lasted that long.

Investors from individuals to large institutions such as pension and hedge funds have flocked to this duo, won over in part by their low-cost funds and breadth of offerings. The proliferation of exchange-traded funds is also supercharging these firms and will likely continue to do.


Low-cost funds? Yes. Breadth of offerings? Less so. The proliferation of ETFs isn’t supercharging anything. In fact it’s a sideshow; everything important is happening in a tiny handful of enormous funds. If anything, a decline in the number of ETFs would help the duopoly, rather than hurt them.

Global ETF assets could explode to $25 trillion by 2025, according to estimates by Jim Ross, chairman of State Street’s global ETF business. That sum alone would mean trillions of dollars more for BlackRock and Vanguard, based on their current market share.


Hm. Even State Street, which absolutely has a dog in this fight and wants the ETF market to be as big as possible, is being far more cautious than Bloomberg. If global ETF assets total $25 trillion in 2025, then there’s no way that Vanguard and Blackrock will have 80% of the total. (Currently, their combined market share is about 55%.)

While bigger may be better for the fund giants, passive funds may be blurring the inherent value of securities, implied in a company’s earnings or cash flow.


What on earth does this mean? The inherent value of a security, as implied in a company’s earnings or cashflow, is something any number of analysts can try to calculate, but it’s absolutely not something which passive funds have any influence over whatsoever. Passive funds might conceivably have a marginal effect on pricing, but given what we’ve seen with the stock market over the past few years, we know for a fact that pricing doesn’t remotely reflect fundamentals. (If it does now, it didn’t five years ago; if it did then, it doesn’t now.) If you’re worried that prices are out of whack with fundamentals, you’ve got much bigger things to worry about than passive investment funds.

The argument goes like this: The number of indexes now outstrips U.S. stocks, with the eruption of passive funds driving demand for securities within these benchmarks, rather than for the broader universe of stocks and bonds. That could inflate or depress the price of these securities versus similar un-indexed assets, which may create bubbles and volatile price movements.


Again, the number of indexes is a sideshow, which means nothing. But put that to one side: the idea here is that if some stocks are in a lot of indexes, then that could, erm, “inflate or depress” their price. Well, which one is it? Let’s take the simplest model, which is just that as more money flows into S&P 500 index funds, then the price of S&P 500 stocks goes up relative to other stocks (Tesla, say) which are not in the S&P 500. One disadvantage of this model is that no one has found any evidence that it’s true; but even if it is true, it’s still impossible to imagine how that would cause “bubbles and volatile price movements”.

Basically, the “argument” sketched out by Bloomberg isn’t an argument at all, it’s a series of bonkers non sequiturs. Lots of indexes! Price uncertainty! Bubbles! Volatility! (Never mind that the rise of ETFs has coincided with volatility hitting a a series of all-time lows.)

Stocks with outsize exposure to indexed funds could trade more on cross-asset flows and macro views, according to Goldman Sachs Group Inc. The bank found that, for the average stock in the S&P 500, 77 percent might trade on fundamentals, versus more than 90 percent a decade ago.


This is so badly written I have no idea what it means. But let’s assume it means that ten years ago (which would be end-2007, as the credit crisis was causing all manner of jitters in the markets), 90% of the value of a stock could be attributed to “fundamentals”, and just 10% to broad flows into or out of stocks as a whole. And that today, the equivalent number is 77%. What’s missing here is what happened for stocks which were not in the S&P 500. Did they also drop from 90% to 77%? If so, then indexing and passive investment will have made no difference at all!

That’s not BlackRock’s experience. “While index investing does play a role, the price discovery process is still dominated by active stock selectors,” executives led by Vice Chairman Barbara Novick wrote in a paper in October, citing the relatively low turnover and small size of passive accounts compared with active strategies.


Well of course price discovery is dominated by active stock selectors, they’re the people doing the marginal price setting. If I have $10,000 in an S&P 500 index fund and it’s just sitting there awaiting my retirement, it’s not playing any role in price discovery at all. At any given moment in time, my stocks are worth just what people are trading them for that second. And those second-to-second investors, almost by definition, are active, not passive.

Another concern is that without the prospect of being part of an index, fewer small or mid-sized companies have an incentive to go public, according to Larry Tabb, founder of Tabb Group LLC, a New York-based firm that analyzes the structure of financial markets. That’s because their stock risks underperforming without the inclusion in an index or an ETF, he said. Benchmarks are governed by rules or a methodology for selection and some require that a security has a certain size or liquidity for inclusion.


This is just a repeat of the “stocks which aren’t in an index underperform” canard. There’s no evidence for this, and once again, if you’re looking for reasons why there are many fewer IPOs than in the past, the rise of passive investing would be miles down the list. If anything, it should increase the number of IPOs, since many passive investment vehicles are forced to buy stocks which enter their respective indexes.

We’re not near a tipping point yet. Roughly 37 percent of assets in U.S.-domiciled equity funds are managed passively, up from 19 percent in 2009, according to Savita Subramanian at Bank of America Corp. By contrast, in Japan, nearly 70 percent of domestically focused equity funds are passively managed, suggesting the U.S. can stomach more indexing before market efficiency suffers.


Intuitively, I can imagine that in a world where more than 90% of stocks are in passive portfolios might start having problems with price discovery – although, as arbitrage opportunities became more obvious, money would surely move into aggressive active strategies. In any case, we’re nowhere near that point yet. Even Japan isn’t there. So, there’s nothing to worry about! The whole thesis of this article is bunk.

BlackRock and Vanguard’s dominance raises questions about competition and governance. The companies hold more than 5 percent of more than 4,400 stocks around the world, research from the University of Amsterdam shows.

That’s making regulators uneasy, with SEC Commissioner Kara Stein asking in February: “Does ownership concentration affect the willingness of companies to compete?”


This argument – that when shareholders own shares in lots of competing companies, then those companies have less incentive to compete – is a fascinating one, intellectually, but it has almost nothing to do with passive investing. Active managers are just as likely to buy up shares in multiple companies in sectors they like.

In the U.S., both companies supported or didn’t oppose 96 percent of management resolutions on board directors in the year ended June 30, according to their own reports.


Is that high or low? I mean, it’s high, I understand that. But are Blackrock’s active managers more likely to oppose board resolutions than their passive managers? I don’t think so. Are active investors generally more likely to oppose board resolutions than passive managers? We’re not told, although I can pretty much guarantee that high-frequency traders never vote on anything.

If indexing distorts the market so much that it’s easier to beat, more investors will flock to stock pickers, says Richard Thaler, Nobel laureate, University of Chicago professor and principal at Fuller & Thaler Asset Management.

Right now, though, the duo’s advance appears unstoppable, and the benefits they’ve brought with low-cost investments may outweigh some of the structural issues.

“Given that they’ve grown so big because their fees are so small, these are the kinds of monopolies that don’t keep me up at night,” said Thaler.


I’m with Thaler on this one. Passive investment is great for individual investors, for a host of reasons that this article doesn’t even hint at. And the amount of harm it causes is, as far as I can tell, zero. Let’s not scaremonger.

And also, let’s stop conflating ETFs with passive investment. A huge proportion of trade in ETFs is as part of hedging operations and other active strategies. ETFs are useful for passive investors, yes, but they’re also incredibly useful for active investors. They’re just a pretty great financial innovation. That’s a rare and special thing; it’s worth celebrating, not scaremongering.

Host and editor, Cause & Effect

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