On Friday, if you have any investments whatsoever, you very well may have voted to give Elon Musk a gigantic, $56 billion pay package as the CEO of Tesla. You probably did this without even knowing it.
This happened because of the incredible rise of “passive investing” or “index fund investing,” which has become one of the most popular ways of investing money in the stock market. If you are privileged enough to have a 401(k), an IRA, or any sort of investment account, it is likely that the investments inside it are held in exchange traded funds (ETFs), index funds, or mutual funds that buy shares of a large swath of the stock market.
When people buy passive investment vehicles, they are giving their money to Vanguard, Charles Schwab, Fidelity, or another investment giant, which then buys shares in a big swath of companies. Many of the most popular funds contain lots of Tesla stock, because Tesla is one of the largest companies in the world. Tesla stock makes up 1.11 percent of VOO, a Vanguard ETF that mirrors the S&P 500. It is the 13th-largest holding in that fund. VTI, Vanguard’s “total stock market” ETF contains 3,663 companies. Tesla is the 13th largest holding in VTI, also, making up .95 percent of the entire fund. Tesla also makes up a significant portion of various retirement “Target Date” funds and similar products across different investment firms.
What this means in practice is that, because of its millions of investors who put billions of dollars into its investment vehicles, Vanguard itself has 232 million Tesla shares, and owns 7 percent of the company. It is the second largest shareholder of Tesla stock, behind only Musk himself. This money is not actually “Vanguard’s,” it is the money of all of the investors and 401(k) holders using Vanguard to invest. But Vanguard does not ask those individual investors if they want to give Elon Musk a gigantic raise. Vanguard votes on their behalf.
This is exactly what happened with Musk. On Friday, Vanguard announced that it has changed its vote from “no” to “yes” on whether Musk deserved a massive new compensation package. In an investors note originally obtained by Reuters, the company said it had switched its vote “given the strong alignment of executive pay with shareholder returns since 2018 and the benefits the board asserted related to the motivational value for the CEO in preserving the original deal.” Vanguard also voted to allow Musk to relocate the company from Delaware (which is the site of a big lawsuit about Musk’s pay) to Texas.
We do not yet know how other major investment firms voted on Musk’s compensation package, but most of them likely approved it, because 72 percent of votes cast (which were not cast by Musk himself) supported Musk’s pay raise.
Vanguard’s oversized influence on Tesla is not a one-off. Because of the way passive investing works, Vanguard (and Fidelity, and BlackRock, and State Street, etc) owns huge stakes in most every publicly traded company and can similarly exert its influence on company operations.
Part of the allure of passive investing is that it is passive—these funds basically just mirror the stock market or different sections of it, and they are considered to be one of the easiest and least expensive ways to invest because they have very low fees. They are seen as one of the most responsible ways to save for retirement, and investing in funds via a 401(k) is incentivized by laws passed that makes investing in them tax-advantaged. Passive investing is now the most popular way of investing in the United States.
The massive popularity of them have had the effect of collectively giving huge voting power in the operations of many publicly traded companies to a handful of investment firms. If, for example, you were to try to build your own investment fund that mirrored the S&P 500, you could do this yourself by buying and selling small bits of stock from 500 different companies. This would be a pain in the ass, but if you did this, you would have shareholder rights at each of these companies and could vote at their shareholder meetings. When investing through Vanguard or another firm, you rarely actually get those rights, and the ways that these investment firms vote on your behalf very well may not line up with your values as a person.
This lack of representation is no secret. The founder of Vanguard, John Bogle, who popularized and championed passive investing and who died in 2019, gave a speech in 2017 about the fact that firms like his have amassed a large amount of power and noted that “until recently, nearly all money managers have been conspicuous by their absence from the corporate governance scene, generally endorsing slates of corporate directors and approving management’s proxy recommendations.”
Vanguard, State Street, and BlackRock are experimenting with something called “voting choice,” which was covered in this New York Times article from February: “What the companies are experimenting with isn’t true ‘pass-through voting,’ which would involve asking millions of fund shareholders how they want to vote in thousands of specific proxy contests each year, and then actually casting those individual votes accordingly.” The companies are instead asking their investors a series of vibes-based questions about climate change, “Catholic faith,” “social responsibility,” etc. The investment companies will then take your answers on these questions and will theoretically apply them when shareholder votes come up, aggregated across all of its other investors.
Tesla, of course, is just one company that people may be investing in without actually thinking about it. The massive rise of Nvidia, which is powering AI infrastructure, has made it one of the most-held stocks in various indexes and therefore, by American investors. Unless you specifically seek to avoid investing in companies like Exxon, Shell, Chevron, Amazon, and various financial giants, putting money into passive funds means you are likely putting money into these companies. This tension between "saving for retirement" and "accidentally supporting some of the most destructive companies on Earth" is of course a product of living in a capitalist society; these issues are also behind the broader "divestment" movement.
In recent months there have been a handful of major articles about the incredibly popularity of index funds and passive investing, and the knock-on effects that its popularity might have. The June cover of Harper’s Magazine, for example, asks “Does the rise of index funds spell catastrophe?” The general thesis of this argument is that passive investing has become so popular that it is creating a gigantic bubble in the stock market. People are unwittingly investing in companies regardless of if the companies are well-run or not because the money is apportioned across large numbers of companies regardless of their fundamentals. This means people are just investing in “the market” and not specific winners and losers. All of this investment is driving up stock prices based solely on the fact that people are putting money into these companies at basically regular and predictable intervals, and that one day this bubble will burst.
We have no idea how all of this will turn out, but it is at least worth understanding the general dynamics of how passive investment has given a huge amount of power to firms like Vanguard and BlackRock.
