An analysis indicates that passive-fund titans rarely challenge management decisions that undermine shareholders’ interests
Because of the trillions of dollars that have flown into passive investments over the years, index-fund firms have grown to become major shareholders of a variety of companies across different sectors. That places them in a strong position to influence proposals that are put to a shareholder vote.
But instead of challenging decisions, the largest passive-fund giants are more likely to support moves advanced by the companies in their portfolios — including the worst performers.
“Such votes reflect a larger trend of deference to management,” said a report by Reuters. Based on an analysis conducted by shareholder-voting data firm Proxy Insight for the news outlet, index-fund firms sided with management in a vast majority of proxy votes held by the 300 worst-performing companies in the Russell 3000 index.
“It found that BlackRock voted with management [at the worst-performing firms] 93% of the time, followed by Vanguard at 91% and State Street at 84% during the proxy year ended June 30, 2018,” Reuters said.
In a similar vein, BlackRock reportedly opposed executive pay only 3% of the time at Russell 3000 companies in 2018; Vanguard stood up against such moves just 5% of the time, and State Street reportedly did so just 9% of the time.
The apparent lack of shareholder activism by index-investing giants is problematic when they fail to hold companies accountable for practices that are in conflict with shareholders’ interests. Some activist investors argue that rich executive compensation — a perk that even heads of failing companies are not shy to ask for —and weak disclosure of climate impacts persist because of the low rate of negative votes cast by top investors.
According to industry experts and academics who study corporate governance, index-fund giants are not keen to challenge management decisions for several reasons. Dorothy Lund, a law professor at USC’s Gould School of Law, argued that since they have no mandate to beat the market, they have no financial incentive to ensure portfolio companies are well-run.
Lund also noted that large companies, which have discretion to offer particular fund products as part of their employees’ retirement plans, are a key agent in investment-fund firms’ efforts to recruit retail investors away from active mutual funds. That relationship can make it hard to challenge companies when they become part of a fund’s portfolio.
Another problem comes from the costs involved in real stewardship. Monitoring thousands of firms in stock-market indexes would require considerable investment of manpower and other resources that have little direct payoff to the bottom line of an index fund.
There’s not much room for them to be investing in stewardship, particularly when real stewardship is expensive and you’re charging some customers close to a zero management fee,” said Ron Gilson, a professor at the law schools of Columbia University and Stanford University.
In defence, index-fund firms argue that proxy voting is just part of their regular engagement with portfolio companies. Representatives from BlackRock, Vanguard, and State Street said that they prefer to use emails, talks with executives, and other more private interventions as a way to influence companies on key issues.