How Are Passive Investors Influencing What Companies Do?

The mainstream media has become so obsessed with the US President that it borders on the evangelical. Not until Capitol Hill impeaches him, it would appear, will they rest from their hectoring.

I hope they all have comfortable chairs — it could be a very long wait.

Yet for all the constant noise — often called ‘news’ — the US economy continues to chug along nicely. As Forbes reported this week, jobless claims are at a 49-year low. Unemployment is under 4%.

Meanwhile, the stock markets in the US continue to propel higher.

The Dow Jones is earnestly trying to regain its all-time high from the start of the year. That’s around double where it was just five years ago.

And the NASDAQ, replete with the biggest stocks on Earth, has trebled over the same period.

For the NASDAQ, its leading stocks have been in a race of their own — to be the first US listed stock to reach a $1 trillion valuation.

The winner, by the way, was Apple Inc. It reached the trillion-dollar milestone after strong Q3 results in early August.

And it only took another month for Amazon to follow. It hit the trillion-dollar mark when its shares traded at $2,050 earlier this month.

Microsoft (US$853 billion) and Alphabet (US$825 billion) are now neck and neck in their race to join the trillion-dollar club.

Although Amazon has lost around $100 billion of value over the last week, Wells Fargo recently upped its price target to $2,300. It believes this year Amazon will overtake Walmart in sales of apparel.

Walmart is no slouch either. Last year, it generated just under half-a-trillion dollars in total sales. Amazon’s sales are still only a third of that size at US $186 billion. But it is catching up quickly.

As CNBC reports, J.P. Morgan believes Amazon can match Walmart’s revenue within two to three years.

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Who’s really in control?

The sheer size and reach of these mega-corporations certainly put fear into anyone in their path, like a giant mudslide about to engulf all of capitalism.

With the impending launch of Amazon in Australia last year, shares in local retailers — like Harvey Norman Holdings Ltd [ASX:HVN] and JB Hi-Fi Ltd [ASX:JBH] — really hit the skids. They both lost around one-third of their value.

Amazon’s start, though, was quite inauspicious. As The Sydney Morning Herald reported last month, total direct sales in December 2017 had a grand total of $6.3 million in retail’s busiest period.

It could be years before Amazon puts a serious dent in local retailers’ sales. But it has the financial power to play the long game.

And despite low sales thus far, governments and local businesses are well aware of Amazon’s power. Given their huge footprint, these mega retailers already have a huge global profile.

Of less profile, though, are the shareholders who own these massive companies.

Not the mum and dad investors like you or me. But the exchange traded funds (ETFs), who own such a big (and growing) chunk of their stock. The so-called passive investors.

But don’t be mistaken. These funds aren’t quite as passive as you think.

Passive…really?

With their massive pool of growing funds (in the multi-trillions) ETFs can sometimes be the biggest shareholder in a stock — often in the top four of five.

The job of an ETF is to replicate an underling index, commodity or currency. They don’t actively try to beat an index, just match it.

That’s why they can charge such low fees. They don’t need to employ a swag of analysts and consultants to pour over every stock and sector.

Increasingly, though, ETFs are using their large shareholdings to promote change — like the compositions of company boards, for example.

And as I have written previously, they are also teaming up with hedge funds and other activists, to influence the way management run their companies. 

The test? That they believe any changes will add greater value to a stock.

As shareholders, all of us have a right to attend and vote at AGMs. We can help strike down a remuneration report, or vote against proposed mergers. As shareholders ETFs also have this right.

But the more they vote to influence a company’s direction, the more they will come to the attention of other activist groups.

These aren’t necessarily shareholders. In fact, there’s a very real chance that they are not. Nevertheless, they will pressure the ETF providers to promote their own agenda.

Take American Outdoor Brands Corp [NASDAQ:AOBC]. With a market cap of less than $1 billion, it is just a fraction of the size of mega-companies like Amazon and Apple. But that doesn’t mean it’s not on the radar.

American Outdoors sounds harmless enough. But it is front and centre of the gun debate in the US.

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AOBC’s previous name was Smith & Wesson — the famous gun manufacturer. Given the truly tragic and horrendous spate of school shootings in the US, activists are pressuring AOBC’s biggest shareholder (and the world’s biggest ETF provider, Blackrock) to dump shares in all firearms stocks.

In response, Blackrock is releasing a new series of ETFs that excludes firms which manufacture or sell weapons. It also says it is engaging with firearm manufacturers to promote change in gun reform.

To be clear, this is not to argue for one side or the other. Gun ownership rights is just one of many ongoing debates.

But how do you ensure that a company (which possibly sources thousands of parts) is not exploiting workers at any point in the supply chain?

Or, should an ETF provider support or hinder a sports company, for example, for endorsing an athlete who chooses not to stand for a national anthem?

Well, in the latter example for Nike, institutions hold 81% of its stock. Of these, Blackrock and Vanguard are the two biggest shareholders. Collectively they hold around 20% of all institutional stock.

Add in State Street Corp, and this swells to around one-quarter of all institutionally held stock.

As the biggest block of institutional shareholders, should they let us know where they stand on any issues?

As I say, it’s not to debate about what is right or wrong. We all have our own judgements on that.

But if so-called passive funds are influencing what companies do, then surely regulators must ensure the whole process is much more transparent.

All the best,

Matt Hibbard
Editor, Options Trader


While many investors chase quick fire gains, Matt takes a different view. He is focused on two very clear goals. First: How to generate reliable and consistent income in a low-interest rate world. And second, how you can invest today to build wealth over the next 10–15 years. Matt researches income investments. You can find more of Matt’s work over at Total Income, where he is hunting down the next generation of dividend-paying companies for the future. He is also the editor of Options Trader, where he uses basic options strategies to generate additional streams of income beyond the regular dividend payments. Having worked for himself and with global firms for almost three decades, Matt has traded nearly every asset in existence. But now he is on a very different mission — to help investors generate income irrespective of what the market is doing. It’s about getting companies to pay you a steady, stable income, with minimal stress and the least risk possible. Matt doesn’t believe you have the luxury of being a bull or a bear in the market right now. You have to earn an income from it, regardless of whether stocks are going up or down. By getting the financial markets to pay you an income, you can get to focus on more important things than just money.


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