Index trackers and ETFs now account for nearly 25% of all assets under management, meaning the largest providers are becoming increasingly influential. Often ranking among the largest investors of public companies, they are the ultimate long-term shareholders of listed companies.
They have the power to effect change through voting and engagement – as well as improving investment performance. Despite this, little research has been done to understand how index managers conduct their stewardship.
Unlike active managers, index managers can't sell poorly run companies. But putting up with poor governance is no longer an option as these managers have a fiduciary duty to their investors to push for changes that will increase shareholder value. As large, permanent owners of a wide range of public firms, they have the clout to advance their agendas. Being an active owner is also a means of galvanising managers' reputations as investor advocates.
Our survey of the 12 largest providers of index funds and exchange-traded funds covers three regions – the United States, Europe, and Asia – and includes global asset managers such as BlackRock and Vanguard, and smaller firms that are key passive fund providers in their local markets, such as Schwab and Lyxor.
Most of the firms also operate an active fund business that in some cases is much larger than their passive one. Collectively, the firms surveyed have over $20 trillion of assets under management.
The growth in index managers’ stewardship teams is compelling evidence of the increased commitment to active ownership. For example, BlackRock expanded its team from 20 members in 2014 to 33 today; Vanguard's team went from 10 in 2015 to 21; and UBS will employ 11 professionals dedicated to stewardship by the end of 2017, up from four in 2015. These increases will allow the firms to undertake more and better-quality engagements with companies.
It is clear that voting and engagement activities vary significantly, according to the size, history and philosophy of the company, its investment style and the region it operates in.
Default Position to Vote in Favour
Both actively managed and index-tracking strategies apply their voting policies universally to all portfolios, irrespective of investment style. The only exception is Fidelity, which delegates the full management and voting responsibilities of its index funds to subadvisor Geode.
Large managers with a global reach, such as BlackRock and Vanguard, typically vote for all portfolio holdings where possible as long as the potential benefit of voting outweighs the cost of exercising the right. Smaller firms and those with fewer resources, such as Deutsche Asset Management and Lyxor, focus more on their home country or region, or on their largest holdings. For example, Deutsche AM works with a watchlist of around 700 companies that typically represent around 50% of its equity fund assets under management.
The starting position for all surveyed asset managers is to be supportive of company management and boards, as most votes are routine matters. However, there are significant differences among firms in how they voted, especially with when voting against management.
US asset managers, who have been historically more reluctant to challenge the status quo than their European counterparts, are starting to show more dissent in relation to environmental and social issues. An example was BlackRock and Vanguard supporting a shareholder proposal seeking greater disclosure of climate-related risks at ExxonMobil (XOM).
For some asset managers, voting against management remains a last-resort option. For example, BlackRock will first try to effect change by engaging management teams and will only cast a negative vote if management is unresponsive or takes too long to address BlackRock's concerns. At the other end of the spectrum, Europe's largest asset manager, Amundi, has a strict voting policy and does not hesitate to swiftly vote against management when a proposed resolution fails to comply with its principles.
At BlackRock, Amundi, and UBS, the policy is for active fund managers to vote consistently across all funds, but they retain the authority to vote differently from the house view. This contrasts with the approach adopted at Vanguard and SSgA, where the corporate governance teams have ultimate authority on the final votes.
What is Engagement?
Index managers are also intensifying their efforts around engagement. Of the 12 surveyed firms, nine reported that they undertake direct engagement activities with companies and expressed a willingness to increase their engagements in the future.
Of the three that do not engage, Fidelity's subadvisor Geode and Lyxor have plans to formalise an engagement strategy in the coming months, in line with their commitment to the UN Principles for Responsible Investment. These principles require signatories to be "active owners" and incorporate environmental, social and governance (ESG) issues into their ownership policies. By contrast, Schwab was the only firm to see no compelling reason to set up an engagement programme, citing cost and what it sees as a lack of solid evidence about the benefits of direct engagement.
There is no standard definition of what constitutes an engagement, although all reported that they increased and are expected to increase in the coming years. For some, a fact-finding meeting or call with a company is enough to be recorded as an engagement; others apply a more stringent definition, only classifying meaningful interactions aimed at bringing about change through dialogue with companies. Of engagements disclosed in 2016, 37 were made by Deutsche AM, 120 by UBS and 1,480 by BlackRock. BlackRock and Vanguard a reporting the most significant growth.
The largest asset managers such as BlackRock, Vanguard, and SSgA have a clear preference for one-to-one engagements, ideally behind closed doors. Others, typically smaller firms, are keener to work with peers and share resources, especially in cases when individual engagements would have a low likelihood of success.
Voting Records are Hard to Find
Transparency of voting and engagement activities is an important part of an asset manager's stewardship duties but disclosure practices differ significantly between managers and countries.
Most surveyed asset managers publish voting records for their funds on their websites in countries where the regulator or a stewardship code requires them to. But too often these records are hard to find, and where disclosure isn't a requirement, they may not exist. Very few explain the rationale behind important votes, that is, votes against management, abstentions, or contentious votes. This is certainly an area for improvement. Indeed, the reasons behind a vote allow stakeholders to assess whether the asset manager has voted in line with its policy and in the best interest of shareholders.
Some managers, including BlackRock, Vanguard, and UBS, are averse to disclosing the names of the companies with which they engage. They believe that to build trust and develop constructive long-term dialogues with company management and boards, conversations need to be kept confidential. Some commented that "naming and shaming" can be detrimental. This, however, doesn't seem to be a concern for Amundi, which publishes an annual engagement report detailing nearly every action it had with companies during the year. SSgA also discloses the names of all the companies with which it engages each year, but it only provides full details on a selected number of successful engagements.
More Pressure to Disclose Voting
In the future, we expect increased disclosure of voting and engagement activities. There is already pressure on asset managers to share more details on voting decisions with the public. Equally, more companies will be publicly named and shamed when engagement has failed. This year, BlackRock started publishing – on a very limited basis – statements on its engagements and votes in relation to certain proposals.
We also expect index managers to become more vocal on ESG topics through public statements on their websites, opinion pieces in major publications, speaking engagements, and interactions with the media. Ultimately, this will also influence their product offerings.
As firms’ ESG-dedicated teams continue expanding, the expenditure will continue to rise. This raises the question of whether these firms will be able to absorb the extra cost without increasing their fees. While large asset managers with economies of scale should be able to absorb the additional costs, it might be more of a challenge for the smaller firms. To remain competitive, these firms will have little choice but to either do the minimum required or go down the outsourcing route.
As assets continue to flow into passive strategies and responsible investing becomes increasingly important, one can only expect greater scrutiny of index managers' stewardship activities.
