With more of a bank’s stock and bonds being held by passive funds, Brian Caplen asks: what does this mean for CEOs?
Many a bank CEO has complained about the market’s low rating of the firm’s equity. This is unsurprising given that most CEOs are paid in relation to the stock price. Often, in response, they call in the analysts to berate them for their ‘poor understanding of the bank’.
But if a much larger share of a bank’s equity is held by exchange traded funds (ETFs) based on an index, who is there to argue with? The classic argument against the growing dominance of index funds is that they are less interested in corporate governance than active funds and hence disinclined to tackle such issues as environmental policy and CEO pay.
This may or may not be the case, and the leading providers – three firms, BlackRock, State Street and Vanguard manage about 80% of index money – say they are increasing their resources for stewardship and that they don’t vote in concert, which is another concern that has been raised.
But let’s turn the whole thing around: if CEOs are running banks with passive rather than active funds as the main shareholders, how does this change their strategy? Last week I wrote about how dealing with short-term-focused shareholders was a problem for banks engaged in major long-term digital transformations.
The move from active to passive can only make this situation worse. After all, there is a chance of convincing active investors to stick with your stock and benefit as the gains come through. But passive funds merely track an index, so investment will flow in and out of bank stocks according to how they perform in the relevant index.
Faced with this problem, CEOs can only sit on their hands. Talking to analysts will not help. The same active-to-passive trend is now at work in the bond markets. This clearly has big implications for bond trading desks because it is likely to compress spreads and reduce profits, but does it also affect the type of debt a bank can issue? Can more complicated hybrid instruments or the bonds of smaller less well-known banks be included in ETF pools? Again, making the argument with a bond analyst is a whole lot easier than convincing an ETF manager.
Brian Caplen is the editor of The Banker. Follow him on Twitter @BrianCaplen
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