Maybe active funds will be saved in seven months' time
It's all in the details
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I think we can safely admit that folks in financial services generally enjoy the nitty gritty. They like technical terms and numbers; Excel is a friend, not a foe.
Ah, but which nitty gritty?
I have come to believe the biggest difference between the wildly successful folks in finance and all the rest is not necessarily smarts or crafty people skills, but rather the wisdom to choose the right nitty gritty.
Some details seem positively coma-inducing, until you learn they’ve propelled Vanguard to become the giant it is today. As it happens, those same details have been all over the news recently. Because they seem boring, hardly anyone noticed.
First, let's start with a really good quote. It appeared this week on a story the FT did on how active funds face dim prospects, because investors prefer passives and ETFs. It’s all familiar stuff to readers of this newsletter, but then came this:
“You can be in passive, you can be in ETFs, and you can be in both,” said Ryan Jackson, a manager research analyst with Morningstar. “You don’t have to sell both, but you can’t sell neither.”
Well, many fund houses are currently, so to speak, in neither. Even if they are launching ETFs, it still takes three years to establish a track record, plus there's also the question of distribution. They can convert a mutual fund into an ETF, but that doesn't solve either of those problems.
On the other hand, there's Vanguard, which is in both. But how did it get there to begin with? Glad you asked.
It's all down to an obscure provision of the federal tax code, passed by Congress in 1969. This proved inspiring reading material for George “Gus” Sauter, who was Vanguard’s chief investment officer from 2003 until he retired in 2012:
“I started thinking, if we had a share class of the funds that traded on the exchange, then likely the people with a shorter time horizon would migrate to that share class,” Sauter said.
In the late 1990s he started working with the SEC on ways to add an ETF share class to the firm’s mutual funds. And Vanguard got not just approval but a patent. It could add an ETF share class to any of its index funds. Anyone else had to get permission from Vanguard to do the same.
Well, that patent expired last year. So this week, AllianceBernstein joined a list of firms seeking relief to offer ETF share classes of mutual funds. Just last week, there was a near-identical story about PGIM.
The problems from before just magically vanish: Because it's a different share class of the same mutual fund, you get to keep your track record. You also have the same investors from before. The same pensions providers who are buying your mutual funds could now switch to the ETF. It’s enormously appealing!
Ah, but the nitty gritty.
For one thing, the original patent was granted for index tracking funds. None of Vanguard’s actively managed funds have this dual-share structure. Whereas, in AB's application (and others like it), they ask for permission not just for one specific fund but:
to “other existing or future open-end management investment companies registered under the 1940 Act and series thereof … that are actively managed and advised by the Adviser,” (highlight mine)
Well, three months before the patent was set to expire, a company tried to do this with seven of its actively managed mutual funds...and was rebuffed.
More recently, this whole deal got a boost of urgency thanks to, you’ve guessed it, another fun piece of detail.
Were it just investment managers asking for relief, the SEC doesn't have to commit to a timeline. But one month ago CBOE filed for SEC approval to:
"become the first asset exchange to enable fund issuers to create exchange-traded funds from existing mutual funds." (highlight mine)
Because CBOE is an exchange, the SEC has now 240 days to revert. In nitty-gritty time it's really not that much.
Also Happening:
Once Exxon sued its own shareholders for pestering it with ESG resolutions, it changed the rules of the game. Now, TotalEnergies is being sued by its shareholders, for throwing out a resolution.
The Ethos Foundation plus several institutional investors are suing because the company rejected their resolution. Basically, they want to separate the roles of board chair and chief exec, and the company is saying: "Nope. Not going to."
Thing is, the investors knew the company wasn't going to split the roles:
“Vincent Kaufmann, CEO of the foundation, said: “Voting on this proposed resolution would have had no other consequence for the company than to allow shareholders to share their views, and in doing so to send a signal to the board of directors as it reflects on corporate governance.” (highlight mine)
A deeper fight is brewing here, and I don't mean specifically at Total. It used to be that shareholders never cared much about company resolutions. Then, ESG and "stakeholder engagement" changed what it means for the board to be in service of shareholders:
The board might think their job is to deliver a stable, profitable company for shareholders. But shareholders now believe the board's job is to support them in changing how a company is being run. This is a power clash, and I expect we’ll be seeing more of it.
A warning to the London Stock Exchange has come from the largest UK stocks owner. The Financial Conduct Authority is close to making big changes to listing rules, in an effort to increase London's appeal as a listing destination. And pension funds are worried about the impact of weaker regulations.
See, I think they're looking at this the wrong way. We have an anchoring problem here, people. Instead of constantly comparing the LSE's listing rules to those in the US, we should compare them to China's:
This week, Reuters reports that China ups its scrutiny of local IPO hopefuls. The head of the China Securities Regulatory Commission wants to boost the quality of listed companies. His nickname is "broker butcher", because of tactics such as onsite inspections, and seizing of mobile phones and laptops from company executives. Already, this has led to over 130 Chinese companies withdrawing their IPO applications this year.
Suddenly, LSE’s rules don’t look bad at all!