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The secret power behind America's top companies
Investors appetite for passive funds has quietly transferred ownership -- and shareholder rights -- in a good chunk of Corporate America to just four index-fund managers.
By Jon D. Markman
Investors' growing disdain for actively managed mutual funds has produced a disturbing consequence: Ownership of American public companies is increasingly concentrated in the hands of just four giant index-fund managers.
Through the end of 2003, the world's four largest index-fund firms -- Barclays (BCS, news, msgs), State Street (STT, news, msgs), Fidelity Management and Vanguard Group -- in aggregate held an average of 12.6% of the 20 largest U.S. companies on behalf of their clients. Together, for instance, this elite band owns 15% of IBM (IBM, news, msgs), 15% of Citigroup (C, news, msgs) and 14.5% of Johnson & Johnson (JNJ, news, msgs).
Barclays, a British bank, has emerged as the first among near-equals, as it has paired its new iShares exchange-traded funds business with its long-established pension-fund indexing business to become one of the largest single holders of U.S. companies, if not the largest -- about $1 trillion worth. Fourteen of the 20 largest U.S. public companies now count Barclays as their largest institutional owner.
| Top U.S. companies in fewer hands | | Name | Barclays % | State Street % | Fidelity % | Vanguard % | Top 4 own % | | General Electric (GE, news, msgs) | 3.9 | 2.9 | 2.5 | 2.9 | 12.2 | | Microsoft (MSFT, news, msgs) | 3.6 | 2.8 | 3.9 | 2.0 | 12.3 | | Pfizer (PFE, news, msgs) | 4.5 | 2.9 | 3.1 | 2.0 | 12.5 | | Exxon Mobil (XOM, news, msgs) | 4.2 | 3.0 | 2.3 | 1.9 | 11.4 | | Wal-Mart Stores (WMT, news, msgs) | 3.2 | 2.6 | 1.5 | 1.6 | 8.9 | | Citigroup (C, news, msgs) | 4.5 | 5.0 | 3.9 | 1.9 | 15.3 | | American Int'l Group (AIG, news, msgs) | 3.7 | 2.9 | 5.4 | 2.0 | 14.0 | | Intel (INTC, news, msgs) | 4.5 | 3.1 | 2.3 | 1.7 | 11.6 | | IBM (IBM, news, msgs) | 4.2 | 7.3 | 1.8 | 2.0 | 15.3 | | Johnson & Johnson (JNJ, news, msgs) | 4.3 | 4.4 | 4.6 | 1.2 | 14.5 | | Cisco Systems (CSCO, news, msgs) | 3.7 | 2.9 | 2.8 | 2.0 | 11.4 | | Procter & Gamble (PG, news, msgs) | 4.0 | 3.4 | 2.6 | 2.0 | 12.0 | | Coca-Cola (KO, news, msgs) | 3.3 | 2.9 | 3.1 | 2.0 | 11.3 | | Bank of America (BAC, news, msgs) | 5.0 | 3.1 | 3.6 | 2.0 | 13.7 | | Altria Group (MO, news, msgs) | 3.9 | 3.7 | 2.6 | 1.9 | 12.1 |
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Bold type indicates the fund manager is the top non-insider institutional holder
What happened to shareholders rights?
The concentration of ownership has unsettling implications for the corporate governance issues now grabbing investors attention. Consider the recent shareholder vote over the chairmanship at Walt Disney (DIS, news, msgs), which counts Barclays as its top institutional investor with a 3.5% stake.
Unlike large, U.S.-based shareholders such as the New York and California state pension funds, which held relatively meager positions in the stock, Barclays has refused to publicly reveal its vote on the Disney chairman, or any other matters. We dont discuss how we vote before or afterward, said Barclays Global Investors spokesperson Christine Hudacko.
Barclays Global Investors is a San Francisco-based subsidiary of Barclays, a $60 billion international financial-services group based in London. BGI manages $1 trillion in assets in 2,000 funds, about 70% of which is held in funds that mimic the return of broad market indexes such as the Standard & Poors 500 ($INX), the Russell 1000 ($RUI.X) and the Russell 2000 ($IUX). Hudacko said BGI has a proxy committee that determines how to vote on governance issues on behalf of its pension-plan or iShares shareholders, but does not canvass those shareholders for their opinions.
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The recent vote in Philadelphia on the chairmanship of Disney offers unusual insight. You had an imperial chief executive, a board of directors that has been asleep at the switch, big blocs of shareholders captive to management, and voting rules that do not permit a no vote -- only a withheld vote. And now we learn that the largest shareholder, Barclays, does not even feel obligated to tell its own clients how it voted. The situation reveals that shareholders rights are a thin veneer on top of business as usual.
Outsourcing corporate governance
If the trend toward shifting investment funds from expensive, actively managed accounts to inexpensive, passively managed accounts continues, in a relatively short time, the four large indexers could own (on behalf of their clients) upward of 30% of most major U.S. companies. That would give a small group of proxy voters unprecedented power in shaping American corporate life. And when you consider the increasing role played by the aggressive team at Barclays, you could almost suggest that the trend toward indexing has led Americans to blindly, unexpectedly outsource a large measure of its corporate governance to the British.
Yet nationalistic pride aside, that might not be such a bad thing.
Stephen M. Davis, publisher of an international corporate governance report called Global Proxy Watch, said Barclays actually has a better-than-average record on corporate governance. They are very proactive and have extensive guidelines to manage conflicts of interest, he said.
Few major funds have ever disclosed to their shareholders how they vote their shares in proxy battles. And this culture of keeping votes private between the fund and the company has been a major contributor to corporate misbehavior. Fidelity has long professed to have high standards on corporate governance, but it has never revealed its proxy votes to show how it held to those standards. And Vanguard, which also has articulated high standards for the governance of companies in which it invests, has likewise fought disclosure rules tooth and nail.
Starting in August of this year, the indexers will no longer be able to hide their votes, as a U.S. Securities and Exchange Commission rule will go into effect requiring all fund managers to reveal both their proxy-vote policies as well as their actual proxy votes cast. Hudacko said Barclays plans to set up a page at its Web site in August declaring its proxy positions.
Nell Minow, editor of The Corporate Library, an independent research firm specializing in corporate governance, said large fund managers such as Barclays have had a very good reason for remaining silent on their votes until now: They dont want to alienate their current or potential clients, she said, noting that every large company is currently, or could potentially become, a customer for their pension fund-management services.
Minow said index fund managers eleventh-hour conversion to proxy-vote disclosure will ultimately cast Barclays in a good light, however. She notes that aside from their obvious conflict of interest, index funds are inclined by their nature to vote for the long-term interests of companies. Barclays has always been a very good, very principled owner, she said. They act in accordance with the strictest standards of fiduciaries. They cant trade out of these companies if theyre dismayed, so the only thing they can do is be vigilant about shareholder rights.
Make yourself heard
If youre an index-fund holder and want more of a say in how the funds shares are voted, you could become a shareholder of Barclays and State Street and vote on their proxies. At the moment, that might not be such a bad idea as Barclays, at least, appears to be modestly undervalued and pays a 1.1% dividend.
The companys 2003 earnings report was sound, and although the iShares business is one of the sexiest elements of its story from this side of the pond, it is by no means a high-margin or wildly profitable business. British analysts were more apt to highlight the companys accretive acquisitions, its credit-card and private client business, as well as its success at controlling costs. Shares have appreciated 55% since January 2000, which is a heck of a lot better than the S&P 500s return of -22%. And yet, though analysts expect 8% to 10% growth next year, Barclays trades for a forward P/E multiple of only 11.
The trend toward consolidation of stock ownership might be problematic from a public policy point of view, but theres no reason you cant make a buck off it by buying Barclays at around $37.25 for a long-term hold while youre fingering your worry beads.
Fine Print
To learn more about Barclays, visit its Web site. Its pretty hard to find any mention of the companys iShares business. Its hidden behind the Asset Management link on the home page, which then leads you to the iShares site. . . . To learn more about the new SEC rule requiring investment managers to reveal their proxy votes, visit the regulatory agencys Web site. . . . To learn who the top 15 shareholders of a company are, visit its Ownership page at the MSN Money Web site. Heres the page for Disney and heres the page for Pfizer. . . . Reader Russ Hayden chimed in about the controversy over the damage oil and gas drilling is doing to Americas landscape. Responding to an item at the bottom of this column, he wrote: How ironic that on the same day I am reading your comments from the naturalist Terry Williams, I am also reading about scientific confirmation that Mars once had abundant water supplies. All of us should ask how many generations of our families will be able to enjoy life as we know it if we do not become more environmentally sensitive. Could some of our back yards look like these Mars photos in only another 200 years?
Jon D. Markman is publisher of StockTactics Advisor, an independent weekly investment newsletter, as well as senior strategist and portfolio manager at Pinnacle Investment Advisors. While he cannot provide personalized investment advice or recommendations, he welcomes column critiques and comments at jdm68@lycos.com. At the time of publication, Markman had positions the following securities mentioned in this column: Intel, Cisco Systems, Microsoft, ExxonMobil, General Electric.
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