Bill Ackman: Index Funds Will Take on a More Activist Role
Pershing Square founder Bill Ackman (Trades, Portfolio) is perhaps one of the best-known activist investors in the world. Activists, as their name suggests, take an active role in managing the companies that they own. Of course, any shareholder has the right to involve themselves in the running of their business in theory, but in practice, many investors are happy to leave the running of their companies to management.
In a recent interview with The Knowledge Exchange, Ackman stated his opinion that index funds could take on a more activist role in the future. Here's what that might mean for investors, if it came to pass.
A growing trend
Over the last few decades, index funds have come to control larger and larger sections of corporate America. For activist investors like Ackman, this is significant because an index fund's vote can become the deciding one in matters of corporate governance. Traditionally, index funds have taken a laissez faire approach to running the businesses that they own, but Ackman thinks that this may begin to change:
"Because of their growing influence, index funds are under a fair amount of pressure from their shareholders to oversee the businesses that they own. People thought about the index fund businesses as one with almost no governance, but their increasing ownership of corporate America puts more pressure on them to be more thoughtful. Now, they don't have the resources to lead an activist campaign - I think that requires a more entrepreneurial type of investor - so there has to be a partnership between activist and index funds."
He adds that the problem with index funds is that they compete on the basis of cost - indeed, some large index funds now charge no fees at all. It's very difficult to maintain the kind of staff required to make thoughtful decisions about corporate governance, particularly if the fund in question has stakes in hundreds of businesses, as index funds often do. In fact, the biggest index funds often have to vote on tens of thousands of decisions!
The idea of index funds taking on a more activist role also raises some thorny issues around competition. The spirit of antitrust law is to not allow a single entity to control competing businesses, but this is exactly what index funds do. For instance, Vanguard's Energy ETF holds stakes in both Exxon Mobil (NYSE:XOM) and Chevron (NYSE:CVX), as well as numerous other big players in the oil and gas industry.
It can be argued that this parallel ownership creates an incentive for the businesses to collude and not compete. John D Rockefeller's Standard Oil was broken up because regulators deemed it an illegal monopoly. Now, more than a century later, the energy industry is once again consolidating under single ownership. The hands-off approach employed by index funds has thus far allowed them to argue that their behaviour is not anticompetitive, as they do not currently push for active change in the businesses that they own.
However, if the trend towards activism that Ackman describes continues, there will inevitably come a day when these issues will have to be resolved.
Disclosure: The author owns no stocks mentioned.
Read more here:
Bill Ackman on What He Learned From Warren Buffett and Charlie Munger
Aswath Damodaran: The Limitations of Discounted Cash Flow Analysis
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This article first appeared on GuruFocus.
