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From Securities Regulation Daily, January 21, 2019

Morningstar weighs in on FTC hearings on common ownership

By Amy Leisinger, J.D.

Morningstar has submitted comments on recent Federal Trade Commission hearings on the impact of common ownership by asset managers. Some academics have contended that common ownership by large asset managers, which occurs when equity is held in competing companies, leads to higher prices for consumers, but the organization suggests that the theories do not correctly explain certain trends. In addition, according to Morningstar, the potential policy solutions under consideration would do more harm than good to ordinary investors, and, in any case, the issue is a securities markets issue that belongs with the SEC, not the FTC.

Common ownership. In its comments, Morningstar urges the FTC to develop a framework for evaluating whether the potential costs of curtailing common ownership are greater than the benefits provided investors. Preventing asset managers from offering large-scale index funds or removing the obligation of passive funds to vote on shareholder proposals would harm investors, the organization explains.

Some researchers have recommended that an institutional investor should own no more than one company in a potentially uncompetitive industry unless the investor owns less than 1 percent of the market share. However, Morningstar notes, changes like this to the mutual fund industry would not only affect institutional investors profiting from concentrated holdings, but also ordinary investors that depend on mutual funds.

Further, according to the organization, common ownership provides diversification, which can necessarily involve holding shares in competing companies. Most investor returns can be attributed to the growth of the most successful companies, Morningstar explains, and investors would miss out if funds are forced to choose among leading companies, rather than owning shares in several successful companies. "Adding another layer of stock selection to the process of indexing will cause fees to go up," Morningstar further opined.

To justify changing the benefits of index funds, common ownership would need to have a much larger effect on competition than that current documented, Morningstar states. If common ownership has decreased competition, the issue should be addressed through antitrust actions instead of limitations on diversification, according to the organization.

"As long as managers have incentive to maximize their own firm's value—as most do—an increase in common ownership should not lead to less competitive behavior," Morningstar states.

The letter also explains that Morningstar’s analysts have found evidence that explanations such as "wide moats" better explain abnormal profitability than common ownership. Some firms operate in industries with substantial barriers to entry and can sustain competitive advantages and excess profits over a long period of time, the organization notes.

Any action taken with regard to this issue should be conducted by the SEC, informed by the FTC, according to Morningstar. The organization recommends further standardization of mutual fund disclosures to increase transparency and so that the data can be readily analyzed to find asset-manager voting patterns and to facilitate analysis of potential issues with of common ownership. Regulators should pay particular attention to balancing the benefits with the burdens of reporting, particularly with regard to smaller asset managers, and avoid expanding disclosures to proxy advisory firm recommendations and pension fund votes.

Citing remarks of SEC Commissioner Robert Jackson, the organization reiterated the "need to be very wary of the emerging evidence that there might be an anticompetitive effect" and the fact that concerned parties are "at the beginning, rather than the end, of that conversation as a matter of optimal policy."

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