The antitrust worries about index funds involve common ownership, when the same large investors own a big chunk of the shares in the major corporations in the same industry. Academics have long theorized that common ownership might encourage coordinated behavior among companies linked by the same set of owners. And recently researchers have made some surprising findings, including that high levels of common ownership can lead to higher prices and lower levels of investment, innovation, and output.
Harvard Law School professor Einer Elhauge calls common ownership the greatest anti-competitive threat in the economy today. Index funds “are great for investors,” says Elhauge, “but part of the reason they’re great for investors is exactly because of the anti-competitive effects.” Elhauge says the trusts of the late 19th century that gave rise to today’s antitrust laws also involved a form of common shareholding.
Index fund managers aren’t meeting with companies to secretly carve up markets in smoke-filled rooms. The process critics imagine is more subtle. It starts with the idea that passive funds seek only to match an index’s return and not outperform it. Thus the fund managers lack financial incentives to ensure the companies in their portfolios are competing fiercely with one another. Compare this to an active manager who holds, say, shares of Coca-Cola Co. but not PepsiCo Inc. She might want Coca-Cola to take big risks to crush Pepsi, and invest capital in new products and markets to do so. An investor who holds both, on the other hand, would prefer that Coke and Pepsi avoid price wars.
Such going along to get along may not always be benign. A 2018 study found that, when the same institutional investors are the largest shareholders in branded drug companies and generic drugmakers, the generic companies are less likely to offer cheaper versions of the brand-name drugs. Consumers could be paying higher drug prices as a result. “The potential effects on anti-competitive conduct are really serious,” says Melissa Newham, a Ph.D. candidate at KU Leuven in Belgium and a co-author of the study. It isn’t clear whether funds are somehow pressuring management or management just knows that competing hard isn’t in the interest of their key shareholders.
The power of the index funds is also becoming a concern of social activists. One study found that BlackRock and Vanguard voted against at least 16 climate-related shareholder proposals in which their support would have given the measures a majority of votes. The study, conducted by the nonprofit Majority Action, looked at 41 climate change-related proposals ranging from setting greenhouse gas emission targets to disclosing environmental lobbying activity. #BlackRock and #Vanguard were less likely than their fund company peers to back the resolutions, supporting them less than 15% of the time. State Street voted in favor of climate-related resolutions more often—about 27% of the time—but still less often than its peers did. “I think the large passive managers have a real difficult decision to make,” former Vice President Al Gore told the Financial Times in December. “Do they want to continue to finance the destruction of human civilization, or not?”