BlackRock, Vanguard and State Street collectively are the largest shareholders for 88% of companies in the S&P 500 (they own about 20% of the index), according to a 2017 paper published in the journal Business & Politics.
Interest in environmental, social and governance issues place passive managers’ influence in a new light. How will this clout be used — and should passive managers even vote?
Asset managers have a fiduciary responsibility to vote in the best interests of beneficial owners. As someone who has read every proxy circular and voted every share for funds within my responsibility, I know how much time is involved. Further, voting against management can earn you a trip to the executive floor to discuss “best interests.”
The chair of a public multinational company once threatened to resign from the board of the financial institution for which I worked unless I reversed a vote. (I withdrew the proxy but refused to vote with management).
Globalization and social challenges make shareholder vigilance more important than ever. Pension plans, ETFs and mutual funds have long been passive shareholders, voting as directed by two firms that together control 97% of the North American proxy advisory market: Institutional Shareholder Services (ISS) and Glass Lewis (which is owned by the Ontario Teachers’ Pension Plan and the Alberta Investment Management Corp.).
ISS and Glass Lewis provide convenience and analysis but, in my experience, generally defer to incumbent management. And a study of 175 investment managers with $5 trillion in assets, conducted by the American Counsel for Capital Formation, found the managers followed ISS recommendations 95% of the time.
Proxy advisors also consult with companies about improving ratings on issues such as executive compensation, prompting the Securities and Exchange Commission (SEC) to recommend greater transparency over conflicts.
There are costs for asset managers to oversee the companies they own. Shareholders owning more than 5% of a U.S. public company who are looking to exert influence must file Form 13D with the SEC within 10 days of a position change, which is expensive; those who are only investors file a Form 13G once a year.
Passive managers prefer to use 13Gs, which do not preclude opposing management on excessive pay or over entrenched or interlocking boards. But nobody gets a bonus for opposing or abstaining. BlackRock’s stated preference is to engage management teams directly through meetings. But proxy voting is more tangible and transparent.
Disgruntled active managers can sell their shares, but passive managers can’t. Owning every company in an index means being a long-term shareholder.
Table 1, below, shows the percentage of votes against management and abstentions by Canadian ETF sponsors with more than 1% market share. Votes against management averaged around 8% across providers. BMO’s voting record stands out, with 28% of votes going against management (including abstentions), which are primarily the result of asserting independent board participation on key committees.
Governance for good or evil
The Business Roundtable, a group of 200 CEOs chaired by JP Morgan’s Jaime Dimon, created a stir by including employees, customers and communities — in addition to shareholders — as “stakeholders.”
Given income inequality, climate instability and populist challenges to capitalism, this perspective is interesting. BlackRock chair Larry Fink has committed his firm to sustainable investing, embracing “green” values in his 2020 letter to CEOs.
As a major shareholder, BlackRock believes it encourages companies to adopt environmental standards through the Task Force on Climate-related Financial Disclosures and the Financial Accounting Standards Board. Time will tell.
Concentrated ownership through passive funds could also lead to abuse. A manager owning all companies in an industry, such as airlines or telecommunications, could maximize returns by discouraging competition and keeping prices high.
Passive managers have downplayed their influence, claiming that director and other votes are decided by margins greater than 30%, so even three 10% holders can’t change proxy outcomes. But if large shareholders can’t influence big business, how can smaller ones?
Passive managers can use their growing proxy power to positively influence corporations by making already public voting records more open to comparison and scrutiny. Passive proxy-power has the potential to be transformative in a world that needs it.
Sunlight, in the form of transparency and disclosure, can be the best disinfectant.
Mark Yamada is president of PÜR Investing Inc., a software development firm specializing in risk management and defined contribution pension strategies.