Vanguard has alerted investors that U.S. regulators may impose restrictions on the size of stakes the company can hold in firms, potentially increasing costs and risks for some of the largest index funds globally.
As the world's second-largest asset manager, managing $9.3 trillion in assets as of May, Vanguard has updated disclosures for numerous funds. The company now highlights an increased risk that authorities might enforce long-standing but seldom-applied caps on ownership of individual bank and utility stocks.
Vanguard, along with fellow passive investment giants BlackRock and State Street Global Advisors, faces criticism over its size and voting practices on climate and social issues.
In January, passive U.S. funds surpassed actively managed funds in investment volume for the first time.
Progressive activists have long raised concerns about the influence of large passive investment complexes, which collectively own nearly 25% of many U.S. companies.
In the past three years, conservatives have also voiced objections, accusing these fund companies of using their shareholdings to promote liberal causes, which they label as 'woke capitalism.'
Historically, regulators have permitted investment funds to exceed the 10% cap on ownership of bank and utility stocks as long as they do not seek a management role.
However, the Federal Deposit Insurance Corporation is now considering stricter conditions on these exemptions, while Republican state attorneys general have urged the Federal Energy Regulatory Commission to scrutinize Vanguard's ability to hold large stakes in publicly traded utilities.
Vanguard’s latest disclosures, filed last week with the U.S. Securities and Exchange Commission, caution that the Pennsylvania-based asset manager may not always be permitted to surpass ownership limits in the future.
"It is not always possible to obtain relief, and there is increasing uncertainty about how much relief regulators will grant asset managers like Vanguard for property restrictions," stated the asset manager.
Without regulatory relief, Vanguard may need to sell securities and instead gain indirect exposure to affected holdings through derivatives such as total return swaps or investments in subsidiaries.
The asset manager informed the Financial Times that the new risk warnings "clarify the potential negative consequences of losing regulatory relief on fund costs and performance, as well as the potential tax implications for investors.
We continue to work with policymakers to address questions, concerns, and mitigate these risks," said Vanguard.
A trade association representing asset managers, the Investment Company Institute, reiterated its concerns that strict regulations could impact the returns for millions of U.S. investors.
"Given the importance, we encourage regulators to carefully consider these impacts and avoid changes that hinder the ability of funds to help Americans invest for a secure financial future," said the ICI.
Neither BlackRock nor State Street immediately responded to requests for comment.
Ben Johnson, Head of Customer Service Solutions at Morningstar, noted that the increasing size of the largest asset managers has inevitably led to stricter regulatory scrutiny, which is likely to persist regardless of the outcome of national elections in November.
"The likelihood of unfavorable decisions increases if these companies and their stakes in individual businesses continue to grow," he said.
Jeff DeMaso, editor of the newsletter Independent Vanguard Adviser, commented that "the days when index funds received a regulatory 'free pass' are over.
"Vanguard, managing $10 trillion, is very different from Vanguard managing $1 trillion," wrote DeMaso.
