Passive resistance

Is compulsory stewardship of passive management the way forward for asset managers? We ask four industry insiders

Consider this. You are an asset manager who’s finding yourself having to conduct stewardship over company boards when managing exchange-traded funds (ETF) and other index-tracking products, regardless of whether you agree with the way they are run. 

According to one of the UK’s largest fund management groups, this compulsion is, or soon will be, the reality for many asset managers.

Saker Nusseibeh, Chief Executive of Hermes, which has £28.6bn under management and carries out engagement for another £134bn, recently told the Financial Times the move was necessary to combat an increase in “ownerless” corporations whose shareholders acted as “absentee landlords”.

But what do the experts think? We look at the views of four industry specialists.

The broker’s view Laith Khalif of investment broker Hargreaves Lansdown thinks that the personnel costs of engagement could scare away investors: “Passive fund managers have engaged in a price war in the last two years, pushing the annual fees of some funds down to as little as 0.06%,” he says.

“Low prices are what attract their investors, and putting the structures in place and employing the analysts and staff necessary to engage with management and company boards would inevitably push up those charges.”

Given that the biggest passive fund managers are increasing their involvement in stewardship, while those that combine active and passive management were already engaging with company boards and management, is compulsion really necessary?

The academic’s view Professor John Kay, author of the 2012 Kay Review, in which he condemns the lack of engagement by asset managers with investment companies, has previously said he would not be opposed to some form of compulsion, although he “would prefer to see it happening because people realise the benefits”.  Kay thinks that compulsory stewardship would be in the best interests of asset managers, as it has the potential to increase the value of investee companies. 

Access all areas

Passive investment offers investors a cheap and convenient way to gain access to a wide range of companies included in a stock market index such as the FTSE 100 or S&P 500.

There are two main ways to invest passively: through index tracking funds, open-ended investment companies (OEICs) and unit trusts; and through ETFs.

The fund manager of an OEIC or unit trust creates new shares or units to meet demand from buyers and cancels shares or units to meet obligations to sellers. This is done just once a day.

In contrast, ETF shares are traded on the stock exchange, just like ordinary shares, and can be bought or sold at any time of the day, making them more suitable for investors who want to trade frequently. ETFs tend to be cheaper and more flexible than tracker funds, and cover a wider range of indices, including timber and forestry, clean energy, Vietnam and global infrastructure.
The association’s view Daniel Godfrey, Chief Executive of the Investment Association, does not agree that compulsion would be beneficial. He takes the view that compulsory engagement will achieve less than that carried out on an active, voluntary basis, where the fund manager or investor can see an issue that needs addressing.

“The real key to more effective stewardship by investors and better governance at companies is focus by clients, investment managers and companies on the long term. Most end-beneficiaries have investment time horizons that can be measured in decades,” he says. 

“Investment approaches that seek to deliver sustainable wealth creation at companies over these very long time horizons lead to genuine focus on environmental, social and governance issues rather than tick-box, mechanistic approaches that may satisfy the call that ‘something must be done’, but add little real value.”

The analyst’s view David Patt, UK Corporate Governance Analyst for L&G, questions the term ‘passive’, instead opting for ‘index tracking’.  

He points out that engagement by index tracking managers can have even more impact than that of active managers, because it is targeted at all the companies, or particular types of company, included in an index, rather than individual companies held in a portfolio. As a company can stay in an index for many years, the relationship between company and investor can be a long and well-established one.

“Our job is to increase the value of the whole index, to create value for investors in an index tracking fund,” he says. “We try to be a force for good on environmental, social and governance issues across all the companies in which we have holdings.”

The original version of this article was published in the June 2015 print edition of the Review.
Published: 14 Jul 2015
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