It is rare to find things in life that are actually only good. ETFs seem like that, some kind of silver bullet for the financial markets. The funds, which track stock indexes such as the MSCI World World with 1,600 one-on-one companies, have revolutionized financial investing in recent years. They also allow ordinary investors to invest in the capital markets at low cost and in a broadly diversified manner. The stock markets have been booming for over a decade with interest rates at zero. ETFs are the ideal product to allow the general public to participate in this boom.
The latest figures show that the Germans are also increasingly convinced of these advantages. They have now invested 67 billion euros in ETFs and are saving three million ETF savings plans, mostly with monthly payments. As long as the stock markets continue to rise, everyone is happy.
With so many advantages, one wonders if ETFs have disadvantages. So far, this question has been asked almost only by economists and capital market researchers. They discussed the consequences of the increasing diffusion of index products on the control of companies and on the stock exchange listing. These discussions have so far been theoretical and abstract. But the more powerful ETFs become, the more their negative side effects appear. Product suppliers need to take these questions seriously and find answers quickly.
This became clear four weeks ago with the planned takeover of the residential construction group Deutsche Wohnen by its competitor Vonovia. This failed to meet the required shareholder quota and attributed this, among other things, to the fact that ETFs already hold 20 percent of Deutsche Wohnen shares. Since ETFs are designed to buy and sell stocks only when an index changes, they were unable to express their position on the intended takeover.
This highlights a problem that threatens to worsen the proportion of ETFs in companies all the more: their providers are only replicating the index, they have no position in the stocks in the index, they do not analyze or control the quality or the quality of the companies. managed, that they respect ecological and social criteria, they do not give any assessment and do not contribute in any way to the pricing. ETFs leave all these functions, which are important for the functioning of the stock exchange, to active fund managers. You are passive in any relationship.
ETF providers themselves need to invest more in business analysis
This problem is not trivial because it touches the heart of shareholder democracy. Listed companies are funded by the general public. Special transparency requirements are imposed on them, because investors need to know what they are investing in. At the same time, owners need to control businesses and be able to exercise their veto power if they see them doing the wrong thing.
This control obligation is even stipulated by an EU directive that Germany has transposed into German law on joint-stock companies. Fund companies that do not adequately supervise companies on behalf of their investors are therefore liable to prosecution. ETF providers claim to exercise their voting rights at general meetings. But it is doubtful whether they invest sufficient economic resources in the analysis. After all, it’s their promise to customers to be cheap, not to control businesses.
There is only one way out of the dilemma: ETF providers need to invest more in the analysis of the companies themselves; they cannot leave this job to active fund managers alone. There is no such thing as good free corporate control. The downside for ETF providers will be that they will then have to make their products more expensive. But it should be worth it for them and also for their customers. Companies like VW or Wirecard that have been under-vetted have done a lot of damage recently – for investors and for society as a whole.