BlackRock will give retail investors in its biggest exchange traded fund the chance to participate in proxy voting in 2024, as the $9.4tn asset manager moves to rebut Republican claims that it pursues a “woke agenda”.

The world’s biggest money manager has joined fellow index fund providers State Street and Vanguard in experimenting with ways to involve ordinary investors in voting on shareholder proposals at a time when their collective influence on US companies has come under fire from both left and right.

Investors in BlackRock’s iShares Core S&P 500 ETF will be asked to choose among seven different general policies ranging from voting generally with management to prioritising Catholic values or environmental, social and governance factors. Investors can also tell BlackRock to continue voting their shares. Customers will not be able to cast specific votes on individual companies.

The fund, known as IVV, has more than $342bn in assets, making this the largest retail proxy voting effort to date. Charles Schwab started polling retail investors in three funds last year, Vanguard ran a pilot project involving three funds this spring and State Street launched a larger programme in April.

Republican politicians at the state and federal level have accused big fund managers of putting social and environmental goals ahead of investors’ financial returns, which they all deny. Progressive social activists, meanwhile, are angry that the money managers have been supporting a smaller share of shareholder proposals on climate issues than they did in 2021. The fund managers contend that the proposals have become too prescriptive and are not in investors’ interest.

Both sides contend that the big providers have too much power because they hold as much as 20 per cent of the shares of many US companies.

BlackRock and the other asset managers argue that they simply provide what their clients want, whether it is ESG-influenced investing or a pure focus on profits. Pushing the decisions on proxy voting down to clients helps make that claim more credible. It also could take some of the heat off on particular votes, because the shares will no longer be voted as a single bloc.

BlackRock already gives institutional customers controlling $2.1tn in index assets the option of choosing how their shares are voted, and $555bn had done so by the end of March. In the retail pilot, IVV’s holdings will be voted in proportion to the share of investors who select each policy.

“BlackRock is committed to a future where every investor can have the choice to participate in the shareholder voting process,” said Joud Abdel Majeid, global head of investment stewardship.

The money manager is also working on a UK programme that will allow retail asset owners to vote, but it has not yet been rolled out to customers.

Vanguard’s pilot, which concluded last month, gave retail investors in three of its funds the chance to chose among four different options — vote with management, abstain, ESG or let Vanguard choose. It said in a statement: “We plan to build on the success of our pilot by expanding it for next proxy season so we can further test and validate our approach.”

State Street’s programme, which allows investors to chose among seven options ranging from pro-labour to pro-management, aims to include 82 per cent of all of its eligible equity assets by the end of the year. It is starting with 57 index ETFs and mutual funds. Its flagship S&P 500 fund, SPY, the world’s largest with $431bn in assets, is not eligible because of rules surrounding its structure as a unit trust.

Newly constructed indices often flatter to deceive and rapidly lose the bulk of the ability to outperform they demonstrated in backtesting, according to research from Morningstar.

Based largely on backtested data, a typical new index outperformed its corresponding Morningstar category index by 1.4 percentage points a year during the five years before any fund started tracking it, the researchers found. But that excess total return declined to just 0.39 percentage points a year over the five years after the fund launched. Risk-adjusted performance followed a similar downward trend.

“Indexes tend to experience a drop in performance after a fund starts tracking them,” the researchers concluded.

Peter Sleep, senior portfolio manager at Seven Investment Management, said the findings were unsurprising.

“A lot of smart beta products [ie those not based on market capitalisation-weighted indices] were a product of data mining optimised on historic data and therefore investors should not be surprised if they did not deliver similar levels of alpha [outperformance] as in the backtest,” Sleep said.

The researchers also noted that most indices have shortlived records — when a typical index fund launches it is tracking an index that has existed for less than four months, the researchers found.

They looked at the target indices for nearly 1,000 mutual and exchange traded funds that encompassed a wide array of asset classes and classifications, including US and global equities, fixed income and commodities. They included traditional broad market cap-weighted indices, but also smart beta, environmental social and governance (ESG) considerations and narrow thematic benchmarks.

Only 262 had three years of returns before their fund’s launch and the findings relating to the drop-off in performance related to this subset.

Daniel Sotiroff, senior manager research analyst at Morningstar and lead author of the report, said his team had found nothing to contradict previous academic findings that on average and over the long term broad passive funds outperform actively managed funds.

“But these smaller passive funds — they tend to start to look like active funds at the end of the day,” he said.

The Morningstar research also found that the median number of stocks held by an index-tracking equity fund had declined from about 500 at the end of 1998 to less than 150 by the end of 2022.

Sotiroff pointed out that many recent launches had been “narrow, volatile thematic funds, chasing the hot parts of the market” and that investors should have been applying caution anyway.

Todd Rosenbluth, head of research at VettaFi, however, said that investors appeared to using the different tools available to them in a sensible manner.

“Few investors are owning just narrowly constructed ETFs,” he said. Instead he said most are employing funds tracking broad market cap-weighted indices as the building blocks of their portfolios and complementing them with thematic or smart beta strategies.

Exchange traded fund industry participants are bracing themselves to take on a costly transfer of risk from US retail brokers, such as Robinhood, when the US unilaterally implements T+1 settlement in May next year.

The move, which will reduce the standard US trade settlement cycle of two business days to just one for all securities (US Treasuries already settle on T+1), would reduce “credit, market and liquidity risks” for market participants, according to the US Securities and Exchange Commission.

But critics said the additional costs this will create for many ETFs, including US ETFs with exposure to overseas markets, will disproportionately be borne by non-US investors because most of the rest of the world will continue to operate on a T+2 basis.

Among those critics is the European Fund and Asset Management Association.

Susan Yavari, senior regulatory policy adviser at Efama, said ETFs were particularly exposed to the coming mismatch because of the way they work and referred to the heavy burden being borne by investors outside the US. Efama’s data suggests 42 per cent of the assets of Ucits equity funds are invested in US equities.

In contrast, just a sixth of the holdings of US equity funds are estimated to be invested overseas.

ETFs rely on a primary market of so-called authorised participants who make their money by looking for arbitrage opportunities between the price of an ETF’s underlying securities and the price of the ETF itself.

Investors in ETFs participate in a secondary market trading of the shares of ETFs that the APs create. When T+1 is implemented, European-listed ETFs, for example, will settle in T+2, but any US-domiciled securities they hold will settle a day earlier.

As Yavari explained, on creation of ETF shares, faced with the coming timing mismatch, the authorised participant will step in and fund the position for a day, passing on the cost to the end investor through wider spreads, or the ETF issuer will rely on an overdraft with a broker to still settle on T+1.

“Either way, the shortage of funding will incur a cost, ultimately borne by the investor,” Yavari said.

The change to shorter settlement has been mooted since the meme stock frenzy in January 2021. Retail brokers scrambled to meet sharply elevated collateral obligations sparking regulatory concerns.

“I understand the rationale for risk reduction and improving margin efficiencies. In the specific case of ETFs, however, I personally don’t believe this will make much difference to overall ETF adoption or liquidity, and the pains may outweigh the benefits for some time,” said Joachim Tigler, who until recently was head of ETF trading at ADG Securities, a specialist ETF market maker.

The pains would also stretch to foreign exchange markets, explained Adam Conn, head of trading at Baillie Gifford.

At present, many managers based outside the US complete trade matching processes and then generate and execute settlement of FX orders on T+1. This process ensures payment can be actually completed by T+2.

To do this, managers tend to use CLS Bank, the primary operator of payment-to-payment platforms.

“The need to execute settlement FX between the close of the North American equity markets [4pm EST] and custodian cut-off times, which can be as early as 4.30pm, dramatically reduces the ability to settle through CLS,” said Conn, adding that this situation was likely to lead to an increase in bilaterally settled trades .

“Trading outside of a payment-versus-payment netting platform carries a greater operating and settlement risk,” Conn added.

On top of the increased trading costs, come operational headaches, the cost of which will also eventually be passed to end investors.

As Yavari explained: “It goes without saying that EU firms will have to extend working hours either through night desks in Europe or expanded operations in US to cater to all the cut-off times happening on T+1.”

For managers based in Asia, trying to settle within US T+1 when they have started their day much earlier — Australia is 14 hours ahead of EST and Hong Kong 12 hours — the challenge might be insurmountable.

“It is likely there will be an increase in failed trades for APAC-based investors transacting in US ETFs following the move to T+1, which is purely a timezone issue,” said Jim Goldie, a regional head of capital markets for ETFs at Invesco.

Goldie played down some of the concerns expressed by his peers. While he agreed that brokers in the EU would have long exposure to an ETF for a day and have to fund that position, or hedge the position to align settlement between primary and secondary market trades, he thought costs would be a “fraction of a basis point per day”, which would be worn by the broker or “baked into the spreads they show investors”.

But he agreed the biggest burden would be felt outside the US. “There is a larger proportion of [European] Ucits AUM invested in US securities, relative to US ETFs tracking international securities,” he said.

For Yavari, the potential fall-out is hard to predict. “There will definitely be an increase in the overall cost of trading for EU funds,” she said. “There may also be an impact on the appeal of US securities, given all the associated issues, from an EU perspective.”

The Investment Association, which represents UK investment managers, said: “The shift to T+1 will see the timelines and ability to settle FX trades become more constrained, particularly for UK and Europe-based firms managing on behalf of investors in the Asia-Pacific region. We are working with our members to explore practical solutions to this challenge.”