When Vanguard created the first index mutual fund in 1976, indexing was considered a curiosity (by those who considered it at all). Critics wondered why someone would “settle” for owning the market instead of trying to outsmart it. Some proponents of active management even called indexing “un-American.”
Four decades later, the case for indexing is widely known and embraced. Tens of millions of individual investors use low-cost, broadly diversified index funds and ETFs to save for retirement, education, new homes, and secure financial futures. Meanwhile, the protests of high-cost active managers have grown more desperate. Last year, one firm published a report claiming that indexing is “worse than Marxism.”
The latest attack on indexing comes from two professors at the University of Chicago, M. Todd Henderson and Dorothy Shapiro Lund, who call index funds “risky for corporate governance.” They assert that index fund managers don’t care about governance, that they are not up to the task, and that they have too many votes. They propose that index funds should, in effect, give up their voting rights.
That proposal is careless and dangerously misinformed. So before anyone entertains the notion of systematically disenfranchising a large portion of the investing population, I’d like to share how Vanguard views our role as investment stewards.
1. We care deeply about governance. Index fund managers must care as much as—if not more than—anybody else. We essentially own stocks forever, because we can’t sell out of a stock listed on an index. So we’re indifferent, for example, about how shares of Coke performed vs. Pepsi last quarter. (Our index funds have held both stocks every single day since 1976 and will continue to do so, rain or shine, so long as Pepsi and Coke are included in the relevant index.) Therefore, Vanguard’s vote and our voice on governance are the most important levers we have to protect our clients’ investments.
When we detect material risks to a company’s long-term value (such as bad leadership, poor disclosure, misaligned compensation structures, or threats to shareholder rights), we act with our voice and our vote. When companies are governed well, they’re more likely to perform better over the long term. If a rising tide of good governance lifts all boats, that’s good news for all investors.
2. We’re good at it. Vanguard’s Investment Stewardship program is vibrant and growing. Our sector analysts are deep on the issues that pose threats to the long-term value of our investments. In the past year, we’ve engaged with company boards and management teams more than 900 times (up an average of 17% per year since 2013). Every time we speak with a company chairman, CEO, or director, we are acutely aware of the role we serve in representing the economic interests of 20 million Vanguard investors. We also listen to activists, a variety of research providers, and our own network of experts. Then we conduct our own independent analysis—and then we vote.
In some cases, boards and management teams have, for too long, taken the support of their index fund shareholders for granted. The reality is that when an activist’s case for change and their board nominees are strong, we’re more than willing to support them, as we did in about half of the proxy fights over the past year. Even where the case falls short, activists often catalyze a discussion that generates meaningful change over time.
3. One share of stock should always equal one vote. And one million shares should equal one million votes. This is a fundamental governance right that should transcend geography, investment style, and holding period. Large funds with many investors have greater voting power than small funds with fewer investors. Vanguard doesn’t control corporate voting outcomes any more than the State of California controls national elections; we have our proportionate say based on how many shares we own, and we vote our shares based on the best long-term economic interests of our clients. Only when a majority of other shareholders reach the same conclusion does the outcome align with our vote.
Any proposal to concentrate voting power in the hands of active managers threatens to reduce board and management accountability, promote short-termism by silencing the longest-term voices, and distort the incentives for investors and companies. Index funds may be passive investors, but the Vanguard funds are not passive owners. Our clients trust us to represent their interests in boardrooms across the globe. We act on that responsibility with the seriousness and dedication it deserves.