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Vanguard is warning investors of a rising threat that US regulators will impose restrictions on the size of stakes it can hold in companies, potentially driving up costs and increasing risks for some of the world’s largest and most popular index tracking funds.
The world’s second-largest asset manager, with $9.3tn of assets as of May, recently updated disclosures for dozens of funds to highlight the increased risk that authorities will force it to comply with long-standing but rarely enforced caps on the ownership of individual bank and utility stocks.
Vanguard’s warning comes at a time when it has come under fire, along with the other two passive investment giants BlackRock and State Street Global Advisors, for their sheer size and voting record on climate and social issues. Passively managed US funds in January passed their actively managed counterparts in assets under management for the first time.
Progressive activists have long sounded alarms about the power of the large passive investment complexes, which collectively own nearly 25 per cent of many American companies. In the past three years, they have been joined by conservatives who complain that the fund companies are using their shareholding to push liberal causes that they dub “woke capitalism”.
Historically, regulators have allowed investment funds to exceed the 10 per cent ownership caps on bank and utility shares that normally triggers additional responsibilities, as long as they do not seek a management role. But the Federal Deposit Insurance Corporation has begun considering whether to impose tighter conditions on those waivers, while Republican state attorneys-general have pressured the Federal Energy Regulatory Commission to review Vanguard’s ability to hold large chunks of publicly traded utilities.
Vanguard’s latest disclosures, filed last week with the US Securities and Exchange Commission, warn that the Pennsylvania money manager may not be always able to breach the ownership maximums in the future.
“It is not always possible to secure relief, and there is an increasing amount of uncertainty around how much ownership limitations relief regulators will grant to asset managers like Vanguard,” the asset manager said in the language it added to the funds’ prospectuses.
Without regulatory relief, Vanguard could be forced to sell off securities and instead buy indirect exposure to affected holdings using derivatives like total return swaps or investing in subsidiaries. The asset manager told the Financial Times that the new risk statements “make clear the potential negative consequences a loss of regulatory relief could have on fund expenses and performance as well as the potential tax consequences for investors.
“We continue to work with policymakers to answer questions, address concerns and minimise these risks,” Vanguard said in a statement.
A trade association representing asset managers, the Investment Company Institute, reiterated its concerns that heavy handed regulation could hamper returns for millions of US investors.
“Given the stakes, we encourage regulators to carefully consider these impacts and avoid making changes that will impede funds’ ability to help Americans invest for a secure financial future,” a spokesperson for the ICI said in a statement.
Neither BlackRock nor State Street responded immediately to requests for comment.
Ben Johnson, head of client solutions at Morningstar, said the increasing size of the largest asset managers had inevitably ushered in tighter regulatory scrutiny, and that the pressure would be likely to continue, no matter who wins in November’s national elections.
“The chance [of unfavourable rulings] only goes up as these firms, and their stakes in individual entities, continue to grow,” he said.
Jeff DeMaso, editor of the Independent Vanguard Adviser newsletter, said Wednesday that “the days of index funds getting a regulatory ‘free pass’ are over”.
“Vanguard managing $10tn is a different beast than Vanguard managing $1tn,” DeMaso wrote.