As assets continue to pour into passive strategies and responsible investing becomes more important, index managers’ stewardship activities can be expected to receive greater scrutiny.
A new study by Morningstar seeks to understand the stewardship activities of these providers of index-tracking investments, including traditional index funds, exchange-traded funds and segregated mandates.
Morningstar surveyed the 12 largest index providers across the U.S., Europe and Asia, including both global firms, such as BlackRock and Vanguard, and smaller ones that are key passive fund providers in their local markets, such as Schwab and Lyxor. Most also operate an active fund business that in some cases is much larger than their passive one. Collectively, they manage more than $20 trillion in assets.
“Our research shows that the shift to index investing hasn’t led to an abdication of stewardship responsibilities,” Hortense Bioy, director of passive funds research at Morningstar, writes in a summary of the study findings.
The survey findings show that the biggest index managers have expanded their stewardship or corporate-governance teams, and are increasingly committed to improving the environmental, social and governance practices of their holdings through proxy voting and engagement.
Several factors have prompted large asset owners to push for increased oversight:
- The belief that ESG integration and active ownership practices can positively affect investment performance
- Regulators’ adoption of stewardship codes, including in the U.K., Japan and Switzerland
- The huge growth of the assets they manage
Index managers’ role as active owners is so important because they are the ultimate long-term shareholders of listed companies, according to Bioy. Unlike active portfolio managers, they cannot sell poorly run companies, and so must encourage positive change through voting and engagement.
But index managers do not all undertake stewardship activities in the same way. The data show that voting and engagement activities vary not just according to the size and predominant investment style (passive or active), but also according to asset managers’ philosophy, region and history.
Firms that offer both actively managed and index-tracking strategies apply their voting policies universally to all portfolios, irrespective of investment style. Fidelity is the exception, delegating full management and voting responsibilities of its index funds to subadvisor Geode whose proxy voting policy and activities are separate from Fidelity’s.
“In our view, this setup has the disadvantage of duplicating efforts and limiting the benefits of scale with respect to proxy voting,” Bioy writes.
The scope of voting varies widely across asset managers, depending primarily on their size. Global managers typically vote for all portfolio holdings where possible as long as the potential benefit of voting outweighs the cost of exercising the right. By contrast, smaller firms focus more on their home country or region, or on their largest holdings.
All surveyed asset managers start by supporting company management and boards, as most votes are linked to routine administrative matters. However, voting records turn up significant differences among firms in how they voted, especially with respect to voting against management.
Bioy notes that anecdotal evidence of mounting dissent is beginning to crop up, particularly in the case of U.S. asset managers, which relative to European ones have been historically more reluctant to challenge the status quo, especially in relation to environmental and social issues.
Still, key differences exist in how surveyed asset managers deploy negative votes. For example, BlackRock will use them as a last resort, while Amundi, Europe’s biggest asset manager, swiftly votes against management when a proposed resolution fails to comply with its principles.
Another difference lies in the varying level of authority active portfolio managers have in voting decisions. The policy at BlackRock, Amundi and UBS is for active fund managers to vote consistently across all funds, but lets them retain the authority to vote differently from the house view.
In contrast, corporate governance teams at Vanguard, SSGA and LGIM have ultimate authority on the final votes — this to ensure consistency and efficacy and to minimize potential conflicts of interest.
At the same time, index portfolio managers have no say in the voting of their holdings. Bioy points out that for the highly automated index portfolio management process, delivering index performance is the overriding mandate.
The Morningstar research shows that nine of the 12 firms in the study reported that they had undertaken direct engagement activities with companies and were willing to increase their engagements in the future.
Bioy said it was hard to compare respondents’ activities because no standard definition of what constitutes an engagement exists. For some asset managers, a fact-finding meeting or call is recorded as an engagement, while for others, only meaningful interactions aimed at bringing about change through dialogue with companies is classified as an engagement.
The survey found that most firms with a structured program of direct engagement sought support from their investment teams. However, on the issue of joining forces with other investors, including activists, views were split.
The largest managers preferred one-to-one engagements, ideally conducted in private. Smaller managers typically liked to work with peers and share resources, especially when doing so increased the likelihood of success.
Problems With Disclosure
Transparency of voting and engagement activities is an important stewardship duty of asset managers, but disclosure practices differ greatly between managers and countries owing to national regulatory requirements and customs.
Bioy writes that most surveyed asset managers publish their funds’ voting records on their websites in countries where the regulator or a stewardship code requires this. But these records are frequently hard to find, and may not exist where disclosure is not required.
Not only that, but very few explain the rationale behind votes against management, abstentions or contentious votes. “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,” Bioy says.
Differences are even more pronounced with respect to disclosure of engagements with investee companies. Some managers are averse to disclosing the names of the companies with which they engage. Others publish a detailed annual engagement report.
Morningstar expects increased disclosure of voting and engagement activities, Bioy says, noting that there is already pressure on asset managers to share more details on voting decisions with the public. More companies will be publicly named and shamed when engagement has failed.
Morningstar also expects index managers to become more vocal on ESG topics. Ultimately, this will also influence their product offerings — as it already has in the case of SPDR SSGA Gender Diversity ETF (SHE).
All surveyed managers have experienced costs related to additional human and technological resources allocated to voting and engagement activities, and expenditure will continue to rise as ESG-dedicated teams expand and develop their expertise, according to the study.
— Check out Global Investors Flock to ESG on ThinkAdvisor.