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Jack Bogle’s legacy and the evolution of index funds in control transactions

31 May 2019 | Australia
Legal Briefings – By Robert Nicholson

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Credited by many as the chief instigator of index funds, we examine Jack Bogle’s legacy and the evolution of the role of index funds in control transactions.

IN BRIEF

  • The popularity of index funds among investors is changing the dynamics of the share registries of large cap stocks
  • The way in which index funds are likely to participate in control transactions needs to be factored into their planning

The rise and rise of index funds

A few months ago Jack Bogle passed away, aged 89. Jack founded Vanguard in 1974 after a difficult time at another fund manager. Credited by many as the chief instigator of index funds, it took a while to sell the concept of delivering investors an exposure to the returns of a particular index whilst charging very low fees.

But over the past 20 years the industry has recorded spectacular growth. Jack reportedly died a wealthy man but not as wealthy as you would expect from the founder of an organisation with around $6 trillion in funds under management.

Vanguard is now a substantial shareholder in a large number of ASX listed companies. Black Rock, State Street and others are also major players. Their collective percentage ownership varies from stock to stock as there are so many different mandates and many of them are overlapping. However, they are believed to own up to 20% in many companies.

How index funds work

Index funds do not promise exactly to match the applicable index on a daily basis. But they do aim to deliver returns as close as possible to those of the index.

This means they will typically not own a stock unless it is in the index or very likely to be within a short time period. Similarly, they are unlikely to sell a stock until it has exited the index or is very likely to.

Participation in takeovers

Having regard to their operating model, index funds are unlikely to contribute stock to a stake building exercise or be early acceptors of a bid.

A fund which seeks to apply its mandate strictly will not accept at all and wait to be compulsorily acquired. However some funds are willing to consider selling on market or into a bid to maximise the benefits for their investors once it is clear that the bid is going to be successful.

Index funds are mainly prevalent in relatively large cap stocks. For those stocks the funds can be a major factor in the market for corporate control, especially if there are strategic holders on the register as well. Their growing presence is making it harder to generate momentum even in recommended bids.

Schemes of arrangement

While index funds may not have actively participated in corporate governance in the early days, they are becoming active now and are open to supporting a scheme which is endorsed by an independent expert’s report on the basis that it delivers value for their investors. One fund manager describes its approach to assessing its voting intentions for an index fund with respect to a scheme as no different to that of an actively managed fund.

The challenge in generating momentum under a takeover (perhaps partly due to the presence of index funds) may be contributing to the increasing popularity of schemes.

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