Passive funds may be increasingly popular with investors, but this style of asset management is not flavour of the month for everyone. Many fear passive fund houses, which by their nature do not need to understand the companies they invest in, can erode shareholder value and damage wider society.
But the recent ‘Annual Letter to CEOs’ from Larry Fink (pictured), chairman and chief executive of predominantly passive fund house BlackRock, seeks to counter this view. Sent on 6 January, it said: ‘Globally, investors’ increasing use of index funds is driving a transformation in BlackRock’s fiduciary responsibility and the wider landscape of corporate governance.’
It added: ‘We must be active, engaged agents on behalf of the clients invested with BlackRock, who are the true owners of your company. This responsibility goes beyond casting proxy votes at annual meetings – it means investing the time and resources necessary to foster long-term value.’
Fink’s use of the word ‘active’ is revealing. It suggests being passive in investment style no longer means you have to be passive in corporate governance. Indeed, Fink’s letter says BlackRock intends to double the size of the investment stewardship team in the next three years. But, with more than $6 trillion (£4.2 trillion) in assets under management (AuM) and a current stewardship team of just 32 members, BlackRock may have quite a way to go.
Rival passive fund house Vanguard, which had $4.5 trillion AuM in September 2017, is also increasing its corporate governance profile. In August 2017, Vanguard investment stewardship officer Glenn Booraem wrote that its governance team had doubled since 2015, to 20 members.
In an interview with New Model Adviser®, Booraem added: ‘The focus of our engagement is understanding how the board is positioned to execute company strategy in the long term. Does the board have appropriate diversity to oversee strategy and risks? Is executive compensation linked to relative performance?’
But Aneel Keswani, director of the Centre for Asset Management Research at Cass Business School, voices concerns. ‘An active institutional shareholder can sell shares in a company, but passive shareholders can’t do this. BlackRock and Vanguard might want to get companies to change policies, say for BP to become more environmental, but BP can say: “You have to hold us anyway” and then ignore them.’
Booraem counters: ‘I offer an alternative view. In many respects we see our engagement as a long-term practically permanent owner as more impactful. Rather than look at near-term buy or hold decisions, we look at companies’ long-term results driven by corporate governance.’
Even so, it is hard to dispute passive managers have fewer weapons in their corporate governance armoury than active managers. Moreover, Shade Duffy, head of corporate governance at active fund house AXA Investment Management, said: ‘An active investment style, which requires close monitoring of companies, lends itself to stewardship more than passive does. Our active fund managers are a fundamental part of the resources we bring to stewardship. It’s a key responsibility they have as investment managers.’
Furthermore, increased corporate governance resources come at a cost, which could affect passive fund charges. But Booraem said: ‘Even if we expand our stewardship team substantially, it will continue to be a minute proportion of Vanguard’s overall spending.’
Intriguingly, Fink’s letter to chief executive officers contained the following statement: ‘Your company’s strategy must articulate a path to achieve financial performance.’ We asked BlackRock to clarify what this means, but they were unavailable for comment. It does, though, sound remarkably like an active management approach.
And, for Keswani, this can introduce conflicts of interest. ‘Imagine BlackRock owns Company 1 and Company 2. It may be conflicted if Company 1 wants to take over Company 2. So passive managers may now face the same conflicts as active, and this may affect their attitudes to corporate behaviour.’
Nonetheless, Fink’s comments on the wider shareholder responsibilities of passive managers are welcome, despite kicking up a storm among participants of the World Economic Forum in Davos. Or perhaps because they kicked up such a storm.