21 Nov PUBLIC PENSION CORNER, #22: Bigger Isn’t Better
NEWS:
I. Florida Attorney General Files Suit against Proxy Advisory Duopoly
Yesterday, Florida AG James Uthmeier filed an enforcement lawsuit against Institutional Shareholder Services (ISS) and Glass Lewis, by far the two largest proxy advisory services, alleging that they violated state law by pushing ideologically motivated proxy-vote recommendations:
The complaint, filed in the 14th Judicial Circuit, charges both ISS and Glass Lewis with violating Florida’s consumer protection and antitrust laws, alleging they coordinated their services and steered corporate governance away from financial performance and toward controversial environmental, social, and governance, or ESG, demands.
“Florida is done allowing two unaccountable foreign-owned private corporations to manipulate shareholder votes behind closed doors,” Uthmeier said in a statement. “ISS and Glass Lewis claim to be neutral advisors, but they use their near-total control of the proxy-voting market to push divisive political mandates that threaten retiree savings, distort corporate governance, and undermine the rule of law.”
The lawsuit targets the core business of the proxy-advisory firms, which together control an estimated 90% or more of the market, providing influential voting recommendations to institutional investors, including those managing retirement funds for Florida’s more than 1 million retirement participants.
II. Appeals Court Pauses One of Two California ESG Laws
On Tuesday, a U.S. appeals court issued an injunction that stopped the execution of California’s SB 261, which requires companies with more than $500 million in revenue to report on their climate-related financial risks and which was scheduled to take effect on January 1, 2026. The court did not take action against SB 253, which requires companies with more than $1 billion in revenue to report their Scope 1 and Scope 2 emissions starting next year and their Scope 3 (supply chain) emissions beginning in 2027:
The decision comes in response to a request by the U.S. Chamber of Commerce, which has been actively attempting to have the courts strike down the laws on constitutional grounds, arguing that the new rules would violate the first amendment by compelling businesses to engage in subjective speech….
The new laws will introduce climate-related reporting requirements for most large companies in the U.S., even as other climate disclosure regulations, such as the SEC’s climate reporting rule, appear increasingly less likely to be implemented. The California Air Resources Board (CARB) recently issued a preliminary list of more than 4,000 U.S. companies likely to be required to comply with the new climate reporting laws.
Prior to the new injunction by the Ninth Circuit appeals court, the first climate-related risk reports were set to be published by January 1, 2026.
COMMENTARY
By Stephen R. Soukup, President and Publisher, The Political Forum
“Bigger isn’t Better”
This past Tuesday (November 18), Vanguard – the second-largest asset manager in the world, with more than $11 trillion in assets under management – announced that it is cutting fees on 12 of its largest ETFs and mutual funds in Canada. These cuts come in the wake of similar cuts that the passive-investment giant made in Europe in September and in the United States this past February. In a statement, Kathy Bock, Managing Director and Head of Vanguard Canada, said, “Throughout our history we have emphasized the importance of limiting the cost of investing as lower fees leave more money in investors’ pockets and raise their potential returns.”
From the perspective of an investor – or a fund manager, or an observer, or…whatever – this was an important announcement. Vanguard is doing something significant and powerful here. “More money in investors’ pockets” is absolutely and inarguably a good thing, isn’t it?
I mean…isn’t it?
Well…
Although “more money in investors’ pockets” certainly sounds like a good thing, especially in the case of those investors who are entrusted with the solemn responsibility of managing other people’s retirement funds, it’s important to recognize and understand the context in which Vanguard made these cuts. Fortunately, Michael Green, the chief strategist at Simplify Asset Management, explained that context clearly and concisely in a recent Twitter/X thread:
A 5 bps fee reduction is not “bad.” It’s also not “meaningful” to long-term investor outcomes. What is meaningful is the structural impact of a dominant player cutting fees to levels that are uneconomic for new entrants and therefore anti-competitive.
The narrative that “cheaper is always better” only holds in a market where:
- competition functions,
- entrants can survive,
- liquidity is robust, and
- scale doesn’t create systemic externalities.
Indexing no longer fits those conditions. Fee compression has become a barrier to entry, not a consumer benefit.
The difference between 22 bps and 17 bps is irrelevant to investor returns over a 40-year horizon. But it is absolutely relevant to whether any firm without $10T in AUM can innovate, experiment, or compete….
If the only viable business model is “match a trillion-dollar incumbent’s price,” then innovation dies. Not because investors are harmed by fees, but because the market structure no longer allows competition on anything but fees. That’s not capitalism. That’s ossification.
In his thread, Green identified and explained one of the biggest and most pressing threats to free and fair capital markets that exists today – threats that I have long insisted are extant in the passive investing boom more generally. In both cases, we’re talking about business strategies that are superficially beneficent in that they inarguably provide investors a tangible benefit but do so at the cost of systemic risk and with the ultimate results being the elimination of competition, the destruction of innovation, and the further concentration of capital, power, and decision-making authority in fewer and fewer hands. This is the problem with the scale at which the massive passive firms operate these days. As John C. Coates, the John F. Cogan Jr. professor of law and economics at Harvard Law School, put it in his 2018 essay, “The Future of Corporate Governance Part I: The Problem of the Twelve”: “The effect of indexation will be to turn the concept of ‘passive’ investing on its head and produce the greatest concentration of economic control in our lifetimes.”
Already, four firms – Vanguard, BlackRock, Fidelity, and Capital Group – control roughly 57% of fund industry assets. And while management fees may be falling across the board in the business, fee collections (i.e., revenues from fees) are increasing at these Big Four fund companies. Indeed, as Michael Green suggested above, Vanguard is actually making out like a bandit while other, smaller firms bear the brunt of its strategy:
Although Vanguard has the lowest average management fee among the top 11 firms…its hugeness….enables it to vacuum up the largest share of the industry’s management-fee revenue….
As passive funds have taken share from active ones and investors have sought cheaper options, Vanguard is winning. Its management-fee share increase beats its largest US competitors, growing by nearly 4 percentage points since 2018….
Passive funds have been taking asset share from active funds since at least 1993, and since 2011, passive inflows have consistently swamped those of active funds. Indeed, in 2023, the majority of industry assets under management went from active to passive.
None of this is good for capital markets. And no one should make the mistake of presuming that any of it is unintentional or merely a side-effect of a business strategy built around customers and their needs. This is purely self-interested on Vanguard’s part, and any benefit to customers is a happy coincidence. Any benefit is also likely to be short-lived, as eventually, the damage to innovation – the “ossification” – will trickle down through the markets to everyone.
It is worth remembering here that, in the United States, at least, the rise of stakeholderism and ESG was enabled almost entirely by the concentration of capital and power in the hands of a few large financial players – asset managers, investment consultants, and proxy advisory services. In 2018, when he wrote his famous Wall Street Journal op-ed warning about the threats posed by the monster he created, Vanguard Founder Jack Bogle probably couldn’t have imagined that within a couple of years, his firm would be called “woke” and cited as a purveyor of left-wing politicization of capital markets. Nevertheless, he understood that the power it had – along with the other passive giants – made it a risk to capital markets and, indeed, to the “national interest” more broadly defined. ESG was the first manifestation of the threat posed by that power, but it won’t be the last.
As I have written before, state financial officers and other public fiduciaries may not have much choice when it comes to banking services. Their debt financing needs are often too significant for any but the largest banks to accommodate. At the same time, however, asset management and investment consulting are different. Bigger isn’t necessarily better. And not only will smaller firms be more likely to enable public fiduciaries to meet their responsibilities more easily, they may save the world – or at least the capital markets.
