| It is approximately true that corporations are “owned” by their shareholders. [1] The managers of the company work for the shareholders, and the shareholders have the ultimate power to hire and fire them and to approve major strategic decisions. In practice, modern public corporations are owned mostly by diversified shareholders who are rationally apathetic. If you have $1 million of retirement savings in the S&P 500 index, it would be absolutely insane for you to spend even five minutes thinking about who should be the chief executive officer of Sealed Air Corp., or how much he should be paid, or what Sealed Air’s strategy should be, or what Sealed Air does. Sealed Air represents about 0.016% of your portfolio, so its effect on your well-being is pretty small, and there are 499 other stocks in that portfolio, so you can’t pay attention to all of them. And you own about 0.000003% of Sealed Air’s stock, so your opinion about anything cannot possibly matter to Sealed Air. [2] Your best bet, with respect to oversight of Sealed Air’s management and strategy, is to ignore it completely. On the other hand Sealed Air’s managers can’t just run around enriching themselves and ignoring shareholders. There has to be some oversight. It just has to be delegated: The shareholders have to get someone else to oversee the company for them, so they don’t have to think about it. And this delegation also has to be pretty thoughtless and automatic: It would be insane for you to spend five minutes thinking about who you should hire to oversee Sealed Air for you. There are roughly three mechanisms for this, three sets of people to whom shareholders delegate their power over public companies: - Boards of directors. This is the oldest and most important answer. The board of the company is responsible for the management and oversight of the company. It hires and fires the CEO and makes the strategic decisions, sometimes asking shareholders to vote to ratify them. The board is nominally elected by the shareholders, but in almost every case directors run unopposed: In practice, the board chooses itself, with the current directors deciding whom to add to the board. [3] Why should you trust the board to oversee the company for you? Well, they do have fiduciary duties to look out for you, and if they do a bad job you can sue them. [4] They tend to get paid for their board service in company stock, so they are shareholders themselves and will want to look out for shareholders’ interests. Also, just, one has to assume a certain level of general professionalism in corporate life. These people devote at least several hours a quarter to serving on the board [5] ; they go to meetings and talk to managers; they have impressive resumes and professional reputations and want to be seen doing a good job. The directors understand that their job is to supervise the company on behalf of the shareholders, and mostly they try hard to do that well.
- Professional investment managers. Above, I suggested that if you invest your retirement portfolio in the S&P 500, you are a shareholder of Sealed Air (an S&P 500 company), but probably you aren’t, at least not directly. Probably if you have $1 million in the S&P 500, it’s in an index-tracking mutual fund or exchange-traded fund managed by BlackRock Inc. or Vanguard Group or State Street Corp. or another professional asset manager. You delegate the whole problem of picking stocks, buying stocks and supervising the companies to the managers of your fund. If BlackRock wants to buy Sealed Air stock for you, it will. [6] If BlackRock wants to vote to approve Sealed Air’s executive compensation on your behalf, it will. You don’t care, and shouldn’t. BlackRock is run by professionals who do this for a living, and you pay them to do it so you don’t have to. And they too want to do a good job, both for general professionalism reasons and also to keep you as a paying customer. And part of their job is meeting with the managers of the companies and making sure that those managers are doing a good job.
- Proxy advisory services. BlackRock is gigantic, and it has enough people and money to spend at least five minutes a year thinking about whether to approve Sealed Air’s executive compensation. (Often at big managers these people will work in a separate governance department responsible for thinking about these things, while the portfolio managers who actually pick the stocks will not worry about voting.) But lots of professional investment managers have only billions of dollars under management, not trillions, and it is not necessarily rational for them to put that kind of time into thinking about the Sealed Air compensation vote. Sealed Air might be 0.1% of their portfolio, and they might own 0.003% of its stock instead of 0.000003%, but that’s still not enough for their vote to make a difference to Sealed Air or to their returns. They can’t, for regulatory and fiduciary-duty and shame reasons, simply throw the Sealed Air proxy statement in the garbage. But they can’t, for good sensible time management reasons, read it either. So they outsource this thinking to a proxy advisory service — the big ones are Institutional Shareholder Services and Glass Lewis — that does this professionally. ISS and Glass Lewis will skim the Sealed Air proxy and be like “sure vote for the comp package” and many investment managers will just do what they say.
None of these mechanisms is perfect, and the central point I want to make here is that they don’t have to be because the shareholders don’t have that much reason to care. People do complain, though. The imperfections are obvious: - The board might get a bit lazy. The directors will tend to be buddies with management, they are often former public-company CEOs themselves, and they might identify more with the managers than with the shareholders. If the CEO is doing a mediocre job, they might be inclined to say “ehh good enough let’s double her salary,” while a zealous shareholder representative might fire her.
- The professional investment managers and proxy advisory services might have their own professional biases. For one thing they probably live in New York or Boston and might have different cultural values from other shareholders. And if they have made corporate governance their life’s work, they probably care more about the formalities and norms of corporate governance than the average shareholder would. It is empirically the case that (1) a majority of Tesla Inc. shareholders would like to pay Elon Musk $1 trillion to build robots but (2) ISS and Glass Lewis disagree. Paying a CEO $1 trillion sounds cool to the average Tesla shareholder, but sounds distasteful to someone who has made a career of trying to exercise oversight over CEOs. Also, the shareholder advisers, unlike corporate managers and directors, generally don’t have skin in the game: They don’t get richer if the stock goes up, so they might vote for policies that they personally like even if they’re bad for the bottom line. [7]
This stuff has become a culture-war issue, in part because it genuinely intersects with culture-war controversies — sometimes shareholders will be asked to vote on environmental or social proposals, and proxy advisers will have to take a politically charged position — and in part because CEOs tend to dislike interference from shareholders and so use culture-war rhetoric as a way to limit shareholder power. It is broadly though not always accurately assumed that professional investment managers and proxy advisers are relatively “woke” and left-wing, and so limiting their power — and putting more power in the hands of the board — is the right-wing move. And so in Donald Trump’s presidency there have been efforts to shift power to boards of directors. We talked about the Securities and Exchange Commission’s guidance cracking down on shareholder proposals, because those proposals tend to give more power to investment managers and proxy advisers. And in September, Exxon Mobil Corp., with the SEC’s approval, achieved the dream of every public company: It launched a program in which retail shareholders can delegate their votes to the board. Exxon said: ExxonMobil’s retail investors, many of whom are retired and depend on ExxonMobil’s dividends to support their livelihoods, have voiced significant frustration over the annual time commitment required to vote at our meetings of shareholders. Each year, retail investors face a large number of proposals to vote on. This burden is not just a matter of hours spent; it also disproportionately impacts retail investors who lack access to professionals dedicated to voting. This limits their participation in shareholder democracy.
Yes, it is insane to participate in shareholder democracy, and now they don’t have to. Of course they didn’t have to before: In practice, retail shareholders mostly didn’t vote, which meant that the votes of professional investment managers and proxy advisers carried more weight. Now the retail shareholders can automatically vote with the board, somewhat diluting those professional votes. But for most companies the real prize is not to get retail shareholders to go along with whatever the board wants, but to get index funds to go along with whatever the board wants. Today the Wall Street Journal reports: The White House is exploring new measures to curb the influence of proxy advisers and index-fund managers, wading into a hot-button debate raised by high-profile CEOs including Elon Musk and Jamie Dimon in recent months. Trump administration officials are discussing at least one executive order that would restrict proxy-advisory firms such as Institutional Shareholder Services and Glass Lewis, people familiar with the matter said. That could include a broad ban on shareholder recommendations or an order blocking recommendations on companies that have engaged proxy advisers for consulting work, the people said. Officials also are exploring limits on how index-fund managers are allowed to vote, seeking to curtail the power of such behemoths as BlackRock, Vanguard Group and State Street, the people said. These three together own on behalf of clients roughly 30% or more of many of the biggest U.S. publicly traded companies. One measure being discussed would require these index-fund managers to mirror their votes in line with clients who choose to vote. … ISS and Glass Lewis provide recommendations to asset managers on how to vote on shareholder ballots on topics ranging from executive pay packages to environmental goals. Musk recently lashed out at the firms when they recommended a “no” vote on his historic $1 trillion pay package. Tesla shareholders approved the plan last week. From first principles it really is obvious that direct and indirect shareholders of public companies should outsource most of their voting decisions to specialized professionals: Individual shareholder votes basically don’t matter. But if they do all outsource their voting to the same professionals, then those aggregated votes do matter, at least sometimes, at least symbolically. (Musk got his money!) And so there will be fights over who gets to make the voting decisions, and what decisions they should make.  | | | One of the great intellectual discoveries of modern finance is that, for many purposes, you can treat every stock as a combination of statistical factors. The traditional way to think about a stock is to analyze the company’s financial statements, sample its products, talk to its customers, meet with the chief executive officer to evaluate her handshake firmness, and form a view on its prospects and valuation. And then if the stock goes up, you will explain that with reasons like “sales of the new product were strong” or “the CEO was able to cut marketing costs without affecting sales” or some other company-specific narrative reason. And then there is the modern factor approach where you analyze a stock by saying, like, “it tends to go up when value stocks go up, and when small-cap stocks go up, and its coefficient on the value factor is X, and its coefficient on the size factor is Y, and its coefficient on the CEO handshakefulness factor is Z,” and so on down the line, decomposing each stock into its historical correlation to various statistical factors and themes. I mean, you don’t analyze the stock like that; your computer does. Your computer regresses all the stocks against some sensible list of factors. And then if the stock goes up, you will explain that with reasons like “the value factor outperformed today” or whatever, some statistical market-wide set of stories. There are all sorts of uses and implications of this in the stock market. Quant hedge funds are doing some form of this, analyzing thousands of stocks to figure out their common drivers and then betting that some drivers will do well. “Smart beta” funds do versions of this cheaply and at scale, and big multistrategy hedge funds track their factor exposures to make sure that their portfolio managers are not just picking factors: To earn your keep as a modern fundamental equity portfolio manager, you can’t just make a big bet on the value factor; you have to add some idiosyncratic insight. Or we talked once about the “tax-aware long-short” strategy, which basically involves buying $130 of some stocks and short-selling $30 of stocks that are (1) different stocks but (2) statistically the same, so that you get market performance on $100 worth of stock but generate some tax losses. That product makes no sense if you think “well I want to buy all the good stocks and short the bad stocks”; that product only makes sense if you think “ehhh all the stocks are kind of made up of the same basic statistical exposures.” This has spread well beyond the stock market. There are quants analyzing private equity returns to see how much of them are attributable to standard factors. Or we talked last week about how people used to worry about bond market liquidity, but mostly don’t anymore. The worry was that banks were less willing to buy and sell bonds for their own balance sheets, so if you had to sell a bond, who would buy it? “It turns out,” I wrote, “that the big proprietary trading firms will increasingly intermediate bond trades, and also, more surprisingly, bond exchange-traded funds can help with the job.” That is also in part a story about factor analysis: The quantitative prop trading firms are willing to buy some bonds from sellers, and sell different bonds to buyers, because they have reasonable statistical confidence that the bonds they are selling are essentially the same as the ones they are buying. (And they can pop bonds in and out of ETF balance sheets for similar reasons.) And you can extend it further, to whole asset classes. You can think “well bonds have a correlation of X to interest rates, and stocks have a correlation of Y to interest rates, so really I want to target $Z of exposure to interest rates and I’ll adjust my mix of bonds and stocks to get it.” Or you can think “well the stock market is like 80% bets on artificial intelligence, and the private credit market is like 60% bets on artificial intelligence, and I only want $Q of exposure to artificial intelligence.” There are some statistical drivers of economic performance, and every financial asset has some correlation to those drivers, and with a bit of work you can figure out what the drivers are and measure the correlations, and then you can make investing decisions based on those factors rather than making arbitrary distinctions between traditional asset classes. Here are Bloomberg’s Justina Lee and Lu Wang on the “total portfolio approach”: For decades ... institutional allocators took roughly the same approach to managing the vast piles of cash under their control: They diversified by divvying up the money across asset classes — for example 40% in stocks, 40% bonds and 20% alternatives — then stuck with it by rebalancing now and again when things got out of whack. But a growing list of funds is challenging that convention by turning to a method that ditches the asset-class silos. Instead, they pit investments as disparate as, say, public equities and private credit against each other in search of the best bet for the whole portfolio. Dubbed the Total Portfolio Approach, it’s gaining traction fast — and before month-end it may even be the guiding principle of America’s largest public pension. … For many such allocators, adopting TPA will mean making drastic changes in culture, governance and infrastructure. Meanwhile there are plenty of skeptics who see little more than a buzzy acronym. But to its proponents, TPA is a better fit than the old static model — known as Strategic Asset Allocation — for an unpredictable world where the likes of inflation spikes or geopolitical shocks can easily upend market assumptions. … In the platonic ideal of TPA, a board would trust the investment team to make more ad hoc decisions. Staff would freely share information across asset-class teams and would debate whether they should bet on, say, data centers through listed shares or private loans. Quants would dissect the factor exposures of public and private equity alike. The passive benchmarks that previously loomed over every asset class team would be no more. … If, for example, a PE allocation has risen to 20% from a target of 15%, an SAA investor might be compelled to offload some PE holdings even if liquidity constraints mean pricing is unfavorable. But a TPA fund can cut listed shares instead, since the framework views both as equities driven by similar forces. It seems obviously true that private equity and public equity are related bets that should in some sense be substitutes for each other, but as a practical matter historically those have been different asset classes managed and overseen by different people, and it was hard to opportunistically move between them. But if they are all just statistical correlations then you might as well try. One theory of environmental, social and governance investing is that you should be willing to accept a lower investment return in exchange for making the world a better place. This is not the only theory — an important competing theory is “avoiding environmental, social and governance risks will get you a higher investment return” — but it is an important one. It is not always obvious how making the world a better place and getting a lower investment return would be related. Some evil companies make a lot of money, but some lose money; some good companies lose money, but others do quite well. It’s not obvious from first principles that investing in the good ones would cost you money. There are clearer cases. For instance, you can buy Jamaican catastrophe bonds, where (1) you get back your money with a nice return if no hurricanes hit Jamaica but (2) you lose all your money if a big hurricane hits. If you are an ESG investor, you might buy those bonds in order to probabilistically subsidize Jamaica’s reconstruction efforts after a hurricane. And then, if a hurricane hits, you will want the bonds to trigger so that you lose all your money. If the bonds trigger, you are helping Jamaica. If they don’t, you get a higher return, but a higher return is not what you want. You want to help. You have fiduciary duties blah blah blah, so you won’t just make a donation, but you want some of your money to go toward helping. Bloomberg’s Gautam Naik reports that some Jamaican cat bond holders are thrilled to be wiped out: “It’s actually a good thing that this bond pays out,” Dirk Schmelzer, senior fund manager at Plenum Investments AG, a holder of Jamaica’s cat bond, said in an interview. “It shows how cat bond structures can help support countries get back on their feet again.” … At Plenum, the expectation is that losses associated with its holding of the Jamaica bond will leave a dent of only 0.23% on one of its two cat bond funds, while the other will be untouched. The asset manager has no plans to scale back its interest in World Bank-backed issuances, Schmelzer said. “From an ESG perspective we have a lot of clients who like to see these transactions in the portfolio,” he said. “Losses are losses, but this is a better loss than other ones.” I guess. I mean, probably the best outcome is no hurricane, no? But conditional on the hurricane hitting, it is good from an ESG perspective for the bonds to pay out. Oh man the First Brands bankruptcy estate has the opportunity to do something very funny: Bankrupt auto supplier First Brands Group is seeking to raise new financing backed by receivables invoices, reviving a tool that was once crucial to its operations but also had a hand in its demise. Lazard Inc., one of the company’s advisers, is running a process to determine potential providers of the funding, according to people familiar with the matter. Interested parties include senior lenders already leading a $1.1 billion bankruptcy loan to First Brands, the people said, asking not to be identified discussing private negotiations. Any receivables financing facility would have certain controls on the cash flow from payments of the invoices, sidestepping risks that had wiped out other invoice lenders, the people said. The specific way that receivables financing “had a hand in its demise” is that First Brands was allegedly borrowing against fake invoices. Presumably it won’t do that again? Like: Presumably the new lenders will be extra careful to check? But what if they’re not? What if they are like “ahhh the First Brands bankruptcy estate could not possibly contemplate sending us fake invoices, so there’s no real need to check”? I am just saying there is a fantastic opportunity for comedy, though also for going to prison, here. South Korean meme investors | Whenever people talk about 24-hour stock trading, my first instinct is “that’s for retail investors logging on drunk at 2 a.m. to trade meme stocks,” but then I remember, no, stock markets are global, and the real value of 24-hour trading is that it allows Asian investors to trade US stocks during their day. I have never considered Asian retail investors logging on drunk at 2 a.m. to trade US meme stocks, but apparently that’s a thing. The Financial Times reports: South Korean retail investors are contributing to dramatic swings in the share prices of some US-listed companies, as they take aggressive trading strategies long used in their domestic market to a booming Wall Street. Known for their high-risk tolerance, herd behaviour and use of leverage, South Korean traders have piled into US markets this year, accounting for a significant slice of the trading in some of Wall Street’s most volatile stocks. Their holdings of US equities have nearly doubled this year to a record $170bn at the end of October, according to Korea Securities Depository data. Many have been drawn to the resurgence in meme stocks this year, helping fuel a craze that first took hold during the Covid-19 pandemic. … “Korean retailers are just crazy. They are not like average retail investors in other parts of the world. They are very aggressive,” said Jongmin Shim, Korea equity strategist at CLSA. … Chung Ji-eun … uses a local brokerage’s mobile trading system and often sacrifices sleep to trade US stocks for about two hours from midnight Korea time because of the 14-hour time difference. “It is so easy to buy and sell US stocks in the system. Dopamine keeps me awake late into the night,” she said. “You don’t even have to convert money yourself. It is automatically done.” It is strange to think that frictionless global markets would cause stock prices to be set by the least rational investors but I suppose that is the working theory here. Hedge Fund Giants Are Muscling Into Red-Hot Private Markets. Anthropic Commits $50 Billion to Build AI Data Centers in the US. Elliott seeks to reassure investors as long-term returns fall behind S&P 500. The Fed Is Increasingly Torn Over a December Rate Cut. ‘Sold POTUS a bill of goods’: White House furious with Pulte over 50-year mortgage. Pulte Cites ‘ Portable Mortages’ After 50-Year Idea Draws Fire. Car Loan Delinquencies Hit Record for Riskiest Borrowers. US law firm McDermott Will & Schulte weighs sector’s first private equity tie-up. Exxon-Backed Coalition Sets Out Goals to Fix Carbon Accounting. From Snowflake to Sierra, Every Enterprise Software Firm Is Selling the Same AI Agents. Private equity group Vista to cut staff in favour of AI. “Sports betting is increasingly looking like a slot machine.” Why Build-A-Bear Has Been on an Nvidia-Like Run. Inside the Little-Known World of Private Judges for Hire. “When they weren’t all getting A’s, they were stressed. And now that they are all getting A’s, they are still stressed.” If you'd like to get Money Stuff in handy email form, right in your inbox, please subscribe at this link. Or you can subscribe to Money Stuff and other great Bloomberg newsletters here. Thanks! |
