May 10, 2018
What We’re Reading This Week
Last month, Japan’s SoftBank announced its plan to include companies like Uber, Ola, and Grab (ride sharing) in its Vision Technology Fund.
This is interesting to me, in the same way that Blackrock telling gun companies to make guns harder to buy is interesting to me. Bear with me, there is a connection.
It all stems back to the concept that index funds are Marxist, or at the very least they discourage competition. Many opponents to index funds argue that when large institutions (like Blackrock) create a fund that tracks a particular segment of the market, it funnels investors into buying whole segments of the market. Let’s say for instance, there was an index fund for airlines. If investors wanted exposure to airline companies, they would just buy the fund, which would in turn, buy stock in many different airline companies, typically weighted by market capitalization. In the old, inefficient, and obsolete world of traditional investing an investor would need to choose their favorite airlines and buy the stock individually.
Opponents of index funds argue this creates several problems. One, if a particular airline has an issue, it’s harder for the market to punish them. If most investors own all airline companies through a fund, investors can’t sell just that one stock. Likewise, it discourages competition and encourages collusion. Namely, as an investor, I want my stock to do well. The companies I own do this by increasing revenue, cutting costs, or doing both. In the case of airlines, they could raise ticket costs or pay their staff less money. They have to balance those activities to the extent that they continue to grow their market share. Or, they could work in cycles, by growing market share first, then raising prices and laying off employees. This could conceivably raise the value of my investment. The higher prices create a hole in the market that could be filled by another airline. A competitor could lower ticket prices and potentially steal market share from the other company. This state of competition keeps things efficient.
Unless…the airlines’ largest investor is one single company, like a Blackrock index fund. Blackrock has no real recourse as an investor. If the airline is in the index, then Blackrock…has to buy it. From that perspective, index fund detractors are correct. However, it’s important to say that we haven’t really seen evidence of this.
Now, when you look at Blackrock’s approach to gun manufacturers from the index fund perspective, they seem a little silly. When you look at the Vision Fund, things get more interesting. However, it’s not new. Here’s what we have: 1) A large investor making targeted purchases in companies – that’s active investment management and 2) Said large investor working to advance the cause of its investments – this is a relative of activist investing. Traditional thinking suggests that activist investors are looking to improve a mismanaged company. It’s a contrarian approach in a sense, because traditionally, an activist investor would look for a company with problems. However, one could always buy good companies with the intention of making them better.
The Vision Fund is interesting to me because it’s a glimmer of what may come. Really, active mutual funds and passive indexes are forms of common ownership. There is the potential for a lot of power there. Power that hasn’t existed in the past because these structures have existed as “two legged stools.” The third leg is the new variable. Let’s discuss. Leg one is the company itself. Actively choosing specific companies or passively investing in a group of companies are both ways to decide what to buy, but the method is sort of irrelevant. Making the choice passively provides an additional layer of diversification. The second leg is comprised of the common owners. The investors in the fund. In the past, investors would decide if they wanted an active or a passive approach. Specifically, with active, they needed to assess the investment manager’s ability to pick stocks! The third leg is this nebulous, additional intention. For instance, with the Vision Fund (it’s important to note, you can’t invest in Vision directly) you are relying on both SoftBank’s ability to pick companies, but also you are relying on its ability to direct and add value to those companies.
Blackrock flirted with this structure by using its passive investments to gain meetings with gun manufacturers in order to encourage them to be more socially responsible. To me, the final, most interesting interpretation of this is a large institutional investor that purchases whole market segments and then votes on proxies and attends board meetings! That would be some interesting price action – the value of the underlying securities, the sector choices of the fund company, and their intentions!
That being said, it’s always possible that the continued fracturing of common ownership will erode the institution’s negotiating power and none of this will be relevant.
After that long, long, long blog I think you guys deserve a short one. Bhavesh Patel, the man who put his Tesla in autopilot and then got in the passenger seat was sentenced last week. He was banned from driving for 18 months, making him the first driver to ever be banned from driving for not driving.
Once upon a time, I was tired of writing about Wells Fargo. I’m pretty sure I said everything that needed to be said during the original scandal. However, the bank is at it again! This week on the chopping block are its 401(k) practices. The bank is under investigation for allegedly pushing its 401(k) and other investment clients out of their 401(k) accounts and into more expensive IRAs, some of which involved having the client purchase in-house investment products. Of course, this comes on the heels of paying $1 billion in fines related to mortgage and auto loans where bank employees pushed customers into expensive, unnecessary auto insurance and failed to honor mortgage rate locks. Both of these issues seem incredibly worse than the initial scandal. If you recall, Wells Fargo came under scrutiny for opening fake credit cards and bank accounts for customers in order to hit aggressive sales targets. Truth be told, while committing fraud is always bad, one could make the argument that the bank accounts and credit cards didn’t actually cost the consumer anything while the latter had a very real financial cost to consumers. Despite that subtle difference, the root cause is still the same, bank employees felt pressure to hit sales targets so they cheated. Clearly, this issue spread across multiple channels at the bank. In lending though, you can’t buy a fake house for a client so you have resort to more traditional manipulation.
I have to say, I am starting to feel bad for Wells Fargo. That may seem like an odd position to take but I’ll explain myself. Bank employees are not fiduciaries. This is the issue that I have had with the Department of Labor Fiduciary standard from the beginning. The new laws only serve to further blur the lines between salesperson and fiduciary. Any legislation meant to impact financial services needs to do a better job of drawing that distinction.
You don’t see articles like this about car dealers, even though they try to increase their profit at every turn in a transaction. The same can be said for real estate agents, really, anyone that exists in a sales role. When you buy a car, you know that person does not represent your best interests, they represent the car dealership. It is literally their job to get you to pay as much to their company as possible. The problem is that it is also true of bank employees. Their job is to increase revenue to the bank, not help you. I feel bad for Wells Fargo because it never claimed to be a fiduciary.
Wells Fargo customers: “You sold us stuff we didn’t want or need! You were supposed to help us!”
Wells Fargo: “Why would you think that??”
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