The investing trends for the next decade will likely be shaped by the continued rise of index funds and ETFs. Over the past decade, index funds and ETFs from Vanguard and other major asset managers have seen tremendous inflows. This has led to their growing influence as shareholders and concentration of power. Going forward to 2023 and the next decade, this trend is expected to continue.
Factors like the lower fees and better performance compared to actively managed funds make index funds and ETFs attractive options for investors. As more assets flow into these passive investment vehicles, fund managers like Vanguard, BlackRock and State Street will get even bigger and more dominant. Their voting power and stakes in public companies will keep rising.
However, this concentration of power also raises concerns about the incentives and stewardship capabilities of these giant index fund managers. As they gain more control, their focus on short-term returns over long-term value creation is worrisome. So policymakers and regulators will have to watch if conflicts of interest arise from their business model.
The Big Three will turn into the ‘Giant Three’ by 2030s
Over the past two decades, the proportion of S&P 500 equity managed by the Big Three of Vanguard, BlackRock and State Street has almost quadrupled from 13.5% to 49%. If we extrapolate the past growth trend, the Big Three could end up controlling over 40% of voting power in S&P 500 companies by the 2030s.
Essentially, the Big Three fund managers will metamorphose into a ‘Giant Three’ that dominates voting in most major public firms. This concentration of corporate ownership will be unprecedented historically. It raises troubling questions about stewardship capabilities, conflicts of interest and lack of competition.
As the Giant Three wield voting control across industries, they may end up dictating outcomes like CEO pay, M&A deals, climate change targets and diversity initiatives. This could adversely impact minority shareholders and long-term value creation.
Growth of index funds and ETFs will accelerate
The structural shift from active to passive management is likely to speed up going forward. Lower fees, better performance, growing awareness and retirement savings auto-enrollment into index funds will drive this change. Actively managed funds have suffered over $1.3 trillion in net outflows globally over the past decade compared to almost $3 trillion in inflows for index funds and ETFs.
In particular, the ETF industry will boom from its current $7.7 trillion in assets to over $50 trillion by 2030. Innovation in smart-beta and niche ETFs will attract assets along with the transparency, intraday liquidity and low costs they provide to investors. Thus index funds and ETFs will capture an ever-larger share of investment industry flows.
Dominance of the Big Three index fund managers will rise
The Big Three of BlackRock, Vanguard and State Street together control over 80% of the index funds sector. This dominance will increase as they leverage economies of scale in a fee-sensitive business. Their huge size also allows them to compete rapidly whenever rivals launch innovative strategies. So challengers will find it hard to take significant market share.
Moreover, the liquidity benefits provided by the largest ETFs will be a durable advantage for the Big Three. For instance, the iShares Core S&P 500 ETF (IVV) from BlackRock trades over $25 billion daily, more than the stock exchanges of most countries. This liquidity incentivizes investors to stick with the market leader.
Concerns over incentives and stewardship will rise
As the Big Three become larger and more powerful, their focus on short-term returns will likely grow further. To protect their main business of asset gathering, they will avoid confrontation with management of portfolio companies and generally side with them. This financial dependency can harm their stewardship capabilities and misalign them from the interests of long-term clients.
There could also be worrying conflicts of interest such as favoring their internal investment products as client solutions. Overall, the perverse incentives arising from the index fund business model will become more prominent issues needing regulatory oversight in order to protect investors.
In conclusion, the rise of index funds and ETFs will be the dominant investing trend over the coming decade. Fund managers BlackRock, Vanguard and State Street will grow into a ‘Giant Three’ that controls over 40% of voting power in S&P 500 firms by the 2030s. But their concentration of power raises troublesome questions about stewardship effectiveness, potential conflicts and lack of competition that policymakers will need to monitor closely.