Stewardship and Passive Funds

How the most powerful players in the financial industry exercise their control rights as stewards of capital has important implications for both the health of capital markets and of the planet. In the decade since the global financial crisis, passive investing has reshaped both the asset management industry and corporate ownership structure.

Here’s a look at the role asset managers play in the global stewardship movement.

Using Voting Power to Promote Sustainability 

A substantial amount of the voting power at most large corporations rests in the hands of “The Big Three” asset managers: BlackRock, State Street, and Vanguard. These asset managers come out on top because index tracking fund strategies tend to benefit from being early movers and practicing economies of scale.

Because collectively the Big Three have so much voting power, these “permanent, universal owners” are able to substantially influence corporate-governance arrangements that underpin sustainable business practices.

And now more than ever, large financial institutions that provide passive investing strategies—like the Big Three—have heightened incentives to do so. Namely, they’re responding to growing investor demand, plus increasing evidence of the role that environmental and social factors play in portfolio health.

Regulation Helps Improve Stewardship 

Under both US and EU securities law, investors play a central role in monitoring and shaping corporate-governance practices. This responsibility of investors as active owners has become particularly important for financial market regulators in the wake of the 2007-2008 global financial crisis.

A few ways corporate governance has risen in prominence include:

• sign-on stewardship codes have proliferated;
• investor collaboration on asset stewardship initiatives, particularly ones that address environmental and social issues, has become more global and sophisticated; and
• both the US and Europe have nurtured supportive regulatory environments.

These developments place greater emphasis on the stewardship role of investment fiduciaries. They highlight how proxy voting and ongoing dialogue, or engagement, with corporate boards and senior management address the governance of environmental and social risks.

Can Asset Managers be Good Stewards? 

A growing body of academic literature explores whether the rise of passive investing could lead to stronger investor oversight.

On one hand, it could do so because asset managers offering passive funds:

• are committed to hold broad sections of the equities market and are therefore exposed to systemic risks;
• can leverage their large equity holdings to influence corporate-governance practices to mitigate these risks; and
• can build a brand around action on social and environmental stewardship.

On the other hand, it might not lead to investor oversight because passive asset managers:

• face cost pressures;
• are incentivised to limit spending on global stewardship activities; and
• may face political or business backlash for publicly opposing corporate management.

For now, research on the asset stewardship practices of the Big Three finds that these powerful financial institutions could be doing more in their role as investment fiduciaries (although BlackRock has recently pledged to make ESG a priority).

They have historically been passive voters: predominantly voting in line with management recommendations, particularly on environmental and social issues that shareholders place on the proxy ballot.

When it comes to achieving governance outcomes, the Big Three prefer engagement, or dialogue, with investee companies over proxy voting. Engagement is a potentially powerful tool for stewardship, but since it’s conducted mostly through private communications, it’s difficult to evaluate from available disclosures. Moreover, many argue that engagement is complementary to, not a substitute for, active voting.

How Can Stewardship be More Effective? 

Our research included a review of recent stewardship code and regulatory developments, academic research on asset-manager stewardship, and the successful model for global collaborative investor engagement on climate change represented by the Climate Action 100+ Coalition.

These insights point to two key strategies for mobilizing passive investor stewardship muscle:

• Collaboration with other investors in ESG-themed engagements. This would have the effect of reducing the cost of active stewardship, amplifying the impact and increasing the visibility of asset managers’ contributions.
• Greater transparency around engagements. Stronger disclosure standards around engagements would allow end investors to evaluate impact and therefore use stewardship as a factor in fund selection.

Beyond the Big Three, a growing number of large asset managers are taking a much more vocal stand on the need for coordinated investor action to accelerate the transition to a low-carbon economy.