The Debate Over ETFs and Market Competition

Some critics argue that exchange-traded funds (ETFs) are reducing competition by discouraging companies from staying competitive. Consider two major companies in an index fund—Apple and Microsoft. Since S&P 500 index funds like SPY must hold the underlying stocks, Apple and Microsoft each make up significant portions of these funds. Passive investments now own an estimated 10-15% of every security in the S&P 500, and as more investors pour into ETFs, that ownership will only grow.

Opponents of index funds suggest that this could lead to reduced competition. If Microsoft and Apple are largely owned by passive funds, they face less pressure from shareholders, who don’t have the ability to sell based on company decisions. Some even argue that companies in the same industry may be incentivized to raise prices together, benefiting passive investors who own both. While this theory makes sense on the surface, there’s little market evidence to support it. However, one concern remains: short-term thinking.

The Power of Proxy Voting

Public companies exist to serve their shareholders. In many cases, if a company underperforms, shareholders can sell their stock, pressuring management to improve. But what happens when the largest shareholders are index funds that won’t sell? Instead, they vote their proxies.

At the Evidence-Based Investing Conference, the CEO of Vanguard highlighted this shift:

“We can’t sell when we are in an index… We’re permanent shareholders. We vote. And once companies realize that, it’s surprising how many find their way to Malvern to talk to us.”

While ETFs are largely driven by low costs today, in the future, investors may pay closer attention to how these funds vote their proxies and influence corporate governance.

The Growing Trend of Shareholder Disempowerment

Tech companies, in particular, have moved toward limiting shareholder voting rights. Facebook set the precedent, but Snapchat recently reinforced this trend. After announcing poor earnings and a future app redesign, CEO Evan Spiegel admitted:

“There is a strong likelihood that the redesign… will be disruptive to our business in the short term.”

Snapchat’s stock has dropped 10% since its IPO, but unlike traditional companies, shareholders have little say in management decisions. While investors can still “vote with their feet” by selling their stock, they can’t influence the company’s direction through proxy votes.

This raises an interesting question: Should shareholders have a say in how a company is run, or should management retain full control? There are valid arguments on both sides, as both investors and company leaders can be wrong in equal measure. Ultimately, if shareholders disagree with management, they have one option—don’t buy the stock.

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