This analysis is by Bloomberg Intelligence analysts Eric Balchunas, Gregory Elders and Anna Constantino. It appeared first on the Bloomberg Terminal. 

The rise of passive funds, which now have about $5 trillion in assets, is changing the ownership makeup of U.S. companies. Such funds track benchmark indexes, but that doesn’t mean their managers won’t take an active role in corporate governance. While several issuers offer passive funds, Vanguard and BlackRock have pulled away as the leaders in both total assets and new cash. The two companies account for about 75% of all net flows into U.S. investment vehicles.

Vanguard could own 30% of U.S. stock market before limit reached
Vanguard, the fastest-growing asset manager with $4 trillion in assets, has plenty of room to expand before it hits potential ownership limits on U.S. stocks. Using Apple as a microcosm of the entire U.S. stock market, Vanguard collectively owns 6.3% of the shares, but none of its funds has more than 2%. The biggest holder is the $428 billion Vanguard Total Stock Market Index (VTSMX). As a diversified fund holding good assets, its stake could rise fivefold before running into ownership caps.

Passive Vanguard promises engaged role in corporate governance
The rise of passive investing doesn’t necessarily mean CEOs will face less pressure over corporate governance. Vanguard and BlackRock, which rank among the top three owners of 95% of S&P 500 stocks, say they intend to promote good governance to boost shareholder returns over time, regardless of whether funds that own the shares are active or passively managed. Vanguard, citing a need for independent boards and accountability, reported 800 “engagements” with company managers and directors in the last fiscal year.

Passive funds won’t be pushovers for activist investors or CEOs
The increase in passive-fund assets to about $5 trillion has raised concerns that CEOs and activist investors will have an easier time using these shareholder votes to their advantage. Yet passive-fund issuers such as Vanguard and BlackRock have indicated they won’t be pushovers, insisting they’ll maintain an independent outlook that focuses on long-term performance. In the 18 largest U.S. proxy contests during the 2015 season, BlackRock voted with activists 39% of the time, according to CEO Larry Fink.

BlackRock promotes ESG strategies as key to companies’ growth
BlackRock cites environmental, social and governance (ESG) factors as being key to long-term growth for companies. Of BlackRock’s 41 engagements with management in 4Q, five dealt with environmental concerns such as climate change, while 11 addressed social issues, including gender equality. Discussions typically focused on matters such as business strategy, compensation, board composition and skills, sustainability and capital allocation, according to BlackRock’s quarterly report.

Bloomberg Intelligence’s Eric Balchunas discusses index funds and the rise of passive investing. He speaks with Julie Hyman on “Bloomberg Markets.”

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