Will Advisors Finally Embrace ESG and Sustainable Investing in 2018?

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," explained Hortense Bioy, director of passive funds research at Morningstar, 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; and the huge growth of the assets they manage.

Voting Behavior

Index managers' role as active owners is important because they are the ultimate long-term shareholders of listed companies, says 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.

The scope of voting varies widely across asset managers, depending primarily on their size. Global managers typically vote for all portfolio holdings where possible if 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.

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.

As for disclosure practices, these 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.

Morningstar expects increased disclosure of voting and engagement activities, as well as for index managers to become more vocal on ESG topics. Ultimately, this should influence their product offerings — as it already has in the case of SPDR SSGA Gender Diversity ETF (SHE).