Concentration

No, this is not a blog about the old television game starring Hugh Downs among others called Concentration. Rather, this is about concentration in the financial markets among fund managers, and concentration within those fund managers of what assets they are investing in by virtue of their presence as index fund managers.

Actually, this is not about the old TV game show

The Big Three

As to concentration among fund managers, the three largest are Vanguard, BlackRock, and State Street. You may invest your money in index funds, but some firm is managing those index funds even for the pittance of a few basis points that they charge. Chances are one of these three companies manages the index fund that you own. For instance, do you own the SPY, the largest ETF that tracks the S&P 500 Index? The SPY and all of the related “spider” funds are managed by State Street Global Advisors. The huge iShares family of funds is managed by BlackRock. Vanguard and its founder John Bogle founded index funds and they remain huge ETF managers. Together they had over $15 Trillion (with a T) under management as of 3Q 2019 (Google it). By virtue of their size, one of them is the largest shareholder in about half of all publicly-traded US companies, according to this article. So what, you might say. Well, for one thing, if they are shareholders, they are entitled to vote in individual corporate elections and thereby have a role in the way corporations are governed. If they are just index ETF managers, then they should not be a source of activism in corporate management, wouldn’t you think? Not so fast! Have you read some recent statements by Larry Fink, the head of BlackRock? Fink is concerned with Climate Change and wants all companies to divest themselves of coal. Fink is writing letters to all companies wherein BlackRock is a shareholder (i.e., probably all public companies in the US) warning them to divest of coal or risk being sold by BlackRock. Don’t know how Fink is going to accomplish this, but the point is it doesn’t sound like a letter from a “passive” ETF fund manager.

IMO

The switch from individuals (and institutions, for that matter) investing in individual companies to funds such as ETFs that have low management fees is a good thing in general because of portfolio diversity but it has a flip side. The flip side is that only a few companies manage these ETFs which have become huge. Because they are so huge, the companies that manage these ETFs, particularly the Big Three of State Street, BlackRock, and Vanguard, are in a position to throw their weight around perhaps when they should not. Moreover, what if something exogenous happens to one or more of these Big Three? How would that upend and cause turmoil in the financial markets? Think about a major computer systems hack of one of the three that causes loss of data. How would that be dealt with, and what would be the effect in the markets? We don’t know because this level of concentration is unique, at least in the last 100 years. I’m not recommending this situation gets rectified because I believe on the whole these ETFs are a good thing, but just be aware that there are issues out there that could pop up and cause indigestion.

As to the other area of concentration; namely, that a growing amount of market capitalization is in the very largest of companies, I will deal with in a later blog post.

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