ETFs are often considered ‘passive’ investments, but in recent years their issuers have become much more active when it comes to their voting rights. As ETFs have become more popular, the big 3 issuers – Blackrock (iShares), Vanguard and State Street Global now own significant percentages of many large companies around the globe.
These funds find themselves in a unusual position, their success depends on the returns of the companies they invest in, yet unlike active managers, index funds can’t sell to take a stand on particular issues. ETF issuers are coming under more pressure to take action on corporate matters via their ‘proxy votes’.
Are ETFs becoming activist investors?
We’ve previously looked at how ethical ETFs work. The growing trend of socially responsible investing avoids shares from companies considered to bring negative social or environmental impact and financial changes. Activist investing takes a slightly different approach, it aims to influence a company’s practices and future plans by buying large numbers of shares and using the voting power that comes with it.
Historically, using votes to influence company boards has been associated with hedge funds and active fund managers looking to boost shareholder returns. More recently investors focused on environmental and social governance (ESG) issues have also warmed to this approach. Index funds are also becoming more active when it comes to voting on all sorts of shareholder issues. Many view this as a new phenomenon – the ETF issuers have reached an unofficial and unexpected position of influence.
In the past, ETF issuers had been known to cast ‘friendly’ votes with management. They were just along for the ride. That all changed in August 2017 when Vanguard’s vote against oil giant Exxonmobil’s management was considered by many industry commentators as a significant inflection point.1 That action forced Exxonmobil to increase reporting on climate issues.
State Street Global was the first to call for, and use its vote to, help increase the numbers of women on company boards. It voted against re-election of directors at 400 companies in 2017, all of which had no female board members.2
The 2018 letter from Blackrock CEO Larry Fink said companies must also serve a social purpose and make a positive contribution to society.3 After the recent Parkland shooting, Blackrock quickly said that it had reached out to gun retailers with questions about future business plans and it also threatened gun manufacturers in the USA with further action.4
Some argue ETF issuers are still not putting enough pressure on businesses and have waited too long to become active and use their voting powers. Perhaps that’s because they have only recently become large and influential enough to know their actions would have impact?
All 3 major issues have recently created investment stewardship plans with ESG principles that outline their views. These plans maintain that businesses need to consider climate change and diversity in the workforce as part of their future strategies.
What does the future hold?
Index fund issuers have criticised traditional activists as being disruptive and have emphasised the need for a long-term focus, with action at the annual meeting seen as a last resort.5 Press releases from the large issuers indicate that they don’t have plans to significantly increase their use of voting, however behind the scenes engagement with companies is increasing.
Why could this be controversial?
Some opponents believe index funds have no place imparting their own social views and there are concerns they may overstep if not contained. Their size can also limit the potential impact from other activist investors or smaller shareholder groups.
It could be argued that taking action on social issues may sometimes conflict with the ETF issuers’ primary duty to investors; to drive the best after-cost investment outcomes.
Their activist engagements with companies can be significant expenses at the fund level and not all of their clients are interested in ESG or other social impact issues at the potential cost of returns.
What does Stockspot think?
We expect more debate about whether index funds and ETFs have a moral obligation to act on social issues (and if so which ones?), or if this concentration of power should be curtailed in some way. It’s likely they will heed to the pressures of their own unitholders who have the power to cast the final vote by switching funds if they don’t agree.
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1 ‘Vanguard seeks corporate disclosure on risks from climate change’, Ross Kerber, Reuters, 15/08/2017
2 ‘State Street Votes Against 400 Companies Citing Gender Diversity’, Justin Baer, The Wall Street Journal, 25/07/2017
3Larry Fink’s annual letter to CEOs – A Sense of Purpose
4 ‘BlackRock says it’s time to take action on guns, may use voting power to influence’, Liz Moyer, CNBC, 02/03/2017
5 ‘Hidden power of the Big Three? Passive index funds, re-concentration of corporate ownership, and new financial risk’, Jan Fichtner, Eelke M. Heemskerk and Javier Garcia-Bernardo, Business and Politics 2017; 19(2): 298–326