Passive Investors Evoke Memories of Germany Inc., ZEW Head Says

(Bloomberg) -- The concentration of ownership of German equities in passive investment vehicles such as exchange-traded funds risks undermining competition among companies, according to the head of one of the country’s leading economic institutes.

The rise of passive investing, led by asset-management powerhouses like BlackRock Inc., the world’s largest issuer of index-based ETFs, evokes memories of “Deutschland AG,” according to Achim Wambach, the head of the ZEW Center for European Economic Research in Mannheim and chairman of the Monopolies Commission, which advises the government on competition and regulation. He’s referring to the web of cross-shareholdings in German industry by banks and insurers that emerged in the late 20th century.

If an investment firm like BlackRock holds in its $1.3 trillion of global ETF assets stakes in Bayer AG and Merck KGaA, Germany’s largest publicly traded pharmaceutical companies, “then BlackRock has less interest in Bayer and Merck competing with each other, but rather that both companies are doing well,” he said. “It’s reminiscent of the old Deutschland AG.”

“Deutschland AG was concentrated ownership whereby financial institutions had outsized investments in industrial companies,” said BlackRock Vice Chairman Barbara Novick. “This is a very different situation because BlackRock does not own the assets we manage, our clients do.”

Economic Coagulation

The cozy interlocking shareholdings, which evolved after World War II as financial institutions took stakes in industrial companies to help rebuild Europe’s largest economy, came untangled in the early years of the millennium after Chancellor Gerhard Schroeder’s government scrapped a levy on corporate asset sales.

Wambach is hardly alone in questioning index-based investment strategies. A chorus of critics has started to complain about index funds and their impact on markets. A study from 2015 by researchers at the University of Michigan showed that airfares on average were as much as 11 percent higher because of common ownership.

“In the past, we always criticized the ‘coagulation of the economy,’ in which banks wielded enormous power over companies,” Wambach said. “Now we have these passive investors, which have become very influential as a result of their stakeholdings. Our concern, from a competition standpoint, is common ownership.”

For its part, BlackRock doesn’t see it that way.

‘No Consensus’

“At the economic academic level, there is no consensus that this common ownership problem exists,” Novick said. “It’s quite premature to have remedies where there’s no consensus that there’s a problem.”

BlackRock oversees sizeable stakes in all components of Germany’s DAX Index of 30 largest companies as well as the MDAX Index for medium-sized companies through various funds that it manages, data compiled by Bloomberg show. While passive investors don’t employ activist strategies, like intervening in board appointments and strategy, Wambach said, they hold sway through their voting rights as shareholders and at meetings with company executives.

“We vote shares we’re responsible for,” Novick said. “We engage at board level on topics such as the qualifications of directors, the time they have to devote to their duties, on executive pay, on environmental issues. This has nothing to do with the product or the pricing of products. We’re a very long-term investor.”