The rapid rise of passive investing has been a defining trend of global financial markets over the last 10 years. This trend, along with the growing impact of environmental and social factors on company performance, will play a key role in the future of investment stewardship.
Investment stewardship involves leveraging ownership rights (proxy voting and engagement) to influence the governance of investee companies. For that reason, investment stewardship activities are a crucial part of asset managers’ fiduciary responsibility for fund investors.
We explore the state of stewardship activities, and how passive asset managers can practice stewardship effectively.
Global standards for asset managers’ disclosure of stewardship activities
Many jurisdictions require asset managers to disclose their stewardship activities as part of their fiduciary duty. For instance:
The SEC stipulates that all mutual funds and exchange-traded funds must disclose their proxy voting records and proxy voting guidelines.
The U.K. stewardship code, the first of its kind when it was introduced in 2010, requires asset managers to disclose their engagement activities and material votes. Anticipated amendments would strengthen voting- and engagement-disclosure requirements.
The EU’s Shareholder Rights Directive II, which is set to take effect in the second quarter of 2019, will require both institutional investors and asset managers to disclose information about engagement, significant votes, and their use of proxy advisor services. These disclosure requirements will help ensure that fund shareholders can monitor their funds’ involvement in the governance of portfolio companies.
Why passive investors should actively promote sustainable business models
Passive investing has led to concentration in the asset-management industry. As a result, the largest providers of passive investment vehicles now control sizable stakes across securities markets, which give them considerable influence when it comes to exercising their stewardship activities and responsibilities.
As a growing number of asset managers offer passive investment vehicles, the case for active ownership by asset managers becomes stronger:
By tracking indexes, passive asset managers are exposed to risks they cannot diversify away from, either across markets or over time.
With large enough stakes in portfolio companies, active asset managers capture a greater share of value from governance improvements.
With almost uniformly low fees and competitors following undifferentiated investment strategies, an active stewardship approach is a potentially valuable part of an asset manager’s brand.
Active stewardship is also important because social and environmental risks—such as climate change, income inequality, shifts in demography, changing workforce dynamics, ecosystem loss and environmental degradation, and gender discrimination—serve as a substantial source of investment risk.
Conversely, businesses that invest in workforces, communities, and environmentally sustainable products and modes of production are proving valuable to portfolios and economies. And by working to shape corporate governance and steer economic activity toward these more-sustainable business models, large asset managers can help improve long-term investment performance.
This governance shift has significant implications for active ownership strategies, as asset managers’ stewardship reports are increasingly focusing on the environmental and social themes motivating their engagement and proxy voting.
The rise of active stewardship in the industry
This approach to investment stewardship is spreading throughout the industry: In letters to shareholders, Larry Fink of BlackRock and Cyrus Taraporevala of State Street have both addressed the importance of stewardship for their organizations. Specifically, their words reflect the need for business strategy to align with a stakeholder-oriented purpose or corporate culture.
Academic studies and issue-focused surveys of proxy voting have found that historically, asset managers tend to underutilize their voting power and instead follow management recommendations on the vast majority of ballot items. But recent evidence suggests a gradual shift in asset managers’ voting on social and environmental issues.
As international regulatory pressure for improved transparency around engagement and proxy voting activities continues to grow, environmental, social, and governance indicators like impact and stewardship are expected to play a larger role in driving competition among index fund providers.