Why trackers have a role in holding companies to account
Rapid growth in exchange-traded funds (ETFs) has made a number of their providers some of the biggest investors in the world, particularly in markets like London and New York.
But as these ETFs grow in size and the stakes of fund firms like BlackRock and Vanguard carry more weight in a whole range of listed companies, the debate over how involved they should be in company affairs has ramped up.
ETFs are synonymous with passive investing, whereby a fund buys stakes in companies in an index and simply follows its returns.
But given the plethora of issues affecting companies and their shareholders, it begs the question over whether passive should mean passive in every sense, or if ETFs and their owners should take on all the responsibilities associated with being a shareholder?
‘Passive should always refer to the investment style, not the engagement style,’ says Matt Brennan, head of passive portfolios at AJ Bell.
It’s a view taken by some of the biggest players in the ETF space, with the likes of BlackRock, Vanguard, State Street and Legal & General Investment Management all having large teams looking at stewardship, the idea of being a responsible owner of the assets they invest in.
‘As a provider of ETFs and index funds we take our role as investment stewards very seriously,’ explains Amra Balic, head of BlackRock’s EMEA investment stewardship team.
‘Investment stewardship is how we use our voice as an investor on behalf of our clients. Over 90% of our clients’ equity investments are held through index funds and ETFs, and two-thirds of our clients’ assets are related to retirement.
‘Therefore, our clients are long-term shareholders, and it is our role to engage company leadership on key issues – such as corporate governance and climate risk – on their behalf, to drive the creation of long-term value.’
THE DIFFERENCE BETWEEN STEWARDSHIP AND ACTIVISM
Stewardship is often compared with shareholder activism.Activist investors’ push for change within companies can bring about better corporate governance.
This comparison is reinforced by the Financial Reporting Council’s Stewardship Code, which recognises the role activism may play in improving corporate governance.
But Brennan says stewardship and activism are distinct, and people shouldn’t get confused between the two.
He says: ‘Activist investors are often looking to bring about short-term change to increase the share price.
‘Stewardship is much more around corporate governance, board independence and remuneration. The passive side is very good at that, thinking about what’s good for the company and not looking at short-term gain.’
PUTTING IT INTO PRACTICE
While a lot of the big ETF providers talk a good game on stewardship, how does it work in practice?
‘We always try to vote [at company annual general meetings], and we have direct meetings and discussions with boards and CEOs,’ says Adrienne Monley, head of investment stewardship for Vanguard Europe.
Two of the main issues Vanguard looks at, particularly when voting, are a company’s board of directors and executive remuneration.
‘Do you want the directors to be re-elected? In order to vote yes, the directors or board have to be representing our funds’ interest,’ says Monley, who adds that the stewardship team looks at various data sources to inform their view whether boards and directors are supporting their interests.
She also says her stewardship team will speak directly to directors on this issue, and – while it happens rarely – will not be afraid to tell directors to their face if they think they are underperforming.
Monley says her team are ‘experts’ in the area of remuneration.
‘One of our core beliefs is that when remuneration rewards performance, shareholders do better. We get concerned when we see remuneration packages that reward short-term performance over long-term performance.’
Looking beyond corporate governance and executive pay to areas like climate change there is evidence that you shouldn’t expect radical action from ETF providers.
DO ETF PROVIDERS FALL SHORT?
A recent Morningstar report from the US showed that in the 2019 annual shareholder meeting season, 177 shareholder initiatives addressing social and environmental concerns were voted on at companies’ AGMs, but BlackRock and Vanguard supported only 10% of these resolutions, according to an article by CNBC.
The voting record from ETF Vanguard FTSE 100 (VUKE) shows it voted against resolutions brought by activist shareholders at oil giants Royal Dutch Shell (RDSB) and BP (BP.)demanding they set climate change targets.
On the other hand, it should be noted Vanguard was voting the same way as the vast majority of other shareholders.
Monley counters that while addressing climate change risk is an important part of stewardship, forcing a company to set arbitrary targets – which may be unrealistic and could harm long-term shareholder value – isn’t necessarily the way to go about it.
For those who are looking to invest more ethically, Brennan advises looking more closely at the funds on offer from an ETF provider.
‘If a passive house launches an ESG-focused ETF, but they also have an energy-sector tracker, there can be that conflict as a business? You have to ask, are they really that principled?’
What do you think?
SHOULD ETF PROvIdERS care about what companies in an index get up to? Their role is to provide access to the index, not choose certain stocks. However, they are still representing the collective voice of shareholders.
We would like to hear your thoughts.
Email email@example.com with ‘ETF Stewardship’ in the subject line.