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Why investment stewardship matters for long-term investors

Each year in the lead-up to company reporting season, individuals who invest directly in publicly listed companies receive notifications informing them of their right to vote at a company’s upcoming Annual General Meeting (AGM). The notification also describes the list of resolutions that would be put to a vote as part of the AGM. A person who directly holds shares in a large number of companies can expect a crowded inbox during the peak of proxy voting season, which is during October and November for many Australian companies.

But for the growing number of investors who invest only in managed funds or exchange-traded funds (ETFs), they don’t receive these letters even though they own a portion of the companies.

Instead, the fund managers cast votes (known as ‘proxy’ votes) at company meetings as part of the 'investment stewardship' service - and obligation - that fund managers carry out on behalf of the funds’ investors. While each fund manager does this differently, the professionals in a properly-resourced investment stewardship team have broad financial market experience and deep expertise in areas of corporate governance, policy, regulation, and social and environmental risk analysis.

The why and the how

Proxy voting is not the only activity that occurs as part of the investment stewardship process, and for many managers, it may not even be the most important. The role of fund managers as stewards or trustees of the shares is primarily to be a voice for investors acting in their best interests.

This is a fiduciary responsibility that good fund managers take very seriously and includes actively meeting (or 'engaging') with companies on a regular basis, voting on shareholder resolutions (a vote put forward by an owner of the shares rather than by the company’s management) and, where appropriate, taking part in public advocacy activities.

The aim is to ultimately hold companies accountable for delivering long-term investment returns to investors. This approach seeks to ensure that companies in a portfolio have robust strategies that not only position them for growth and success, but are actively managing risks that are financially material, or entail risks that may lead to short-term gains but impede the company’s long-term performance or value.

For example, investment stewardship teams often place great emphasis on the composition of a company’s board, including factors such as whether the board is sufficiently independent from management and suppliers, and whether it has a suitable mix of skills and experience, and whether the board is appropriately diverse.

Investment stewardship teams also analyse and vote on companies’ executive remuneration practices. Over the long run, company shareholders stand to benefit when executive remuneration plans incentivise a company’s long-term value creation and outperformance versus its industry peers.

Over the past decade, long-term investors have been placing greater focus on the board’s oversight of company strategy and risks, including social and environmental risks. This can include workplace culture issues, treatment of community stakeholders, corporate fraud and financial crimes, large-scale industrial incidents that result in reputational damage, or other practices that pose a threat to people’s health, safety, or dignity. If such risks are not properly managed and overseen, they can erode shareholder value.

The most widespread example of this today, across virtually all industry sectors, relates to climate change risks and how companies are planning to manage their business in response to the increasingly urgent pressure to transition to a low carbon economy over coming decades.

Passive management does not mean passive ownership

Critics of large index fund managers often believe that a 'passive' approach to fund management equates to a passive approach to investment stewardship. In other words, that these fund managers merely invest as directed by the index and have little concern for material environmental, social and governance (ESG) risk.

For Vanguard, the opposite is true. Index funds are designed to buy and hold the shares of the companies in their appointed benchmark in virtual perpetuity (or as long as the shares are included in the index). The funds can’t use discretion to buy more shares of companies deemed to be promising or sell out of companies that may be bad actors.

Issues that are financially material to the long-term investment returns will regularly be on the agenda for index funds and will remain so long after shorter term investors have sold out of their positions. The investment stewardship tools of proxy voting, engagement, and public advocacy are the most important levers that index funds have to ensure that companies are acting in the best interests of their longest-term investors.

Why it matters

People choose to invest through managed funds, index funds, and ETFs for a variety of reasons, including low costs, diversification and ease of implementation. And for those who prefer to keep their investments at arm’s length, it is easy to dismiss this process as unimportant or too complicated to bother engaging with or reading up about.

But while investment stewardship outcomes may not be apparent in a daily share price or a quarterly statement, these teams work relentlessly to promote and safeguard shareholder value over the course of years and decades.

If you care about how your investment performs over the long term and whether it will deliver the returns you reasonably expect, it’s worth the extra step to ensure that the fund’s investment stewardship team is taking a stand on behalf of its investors.

 

Lisa Harlow is Head of Vanguard Investment Stewardship, Asia Pacific. Vanguard Australia is a sponsor of Firstlinks. This article is for general information and does not consider the circumstances of any individual.

For articles and papers from Vanguard, please click here.

 

3 Comments
Ruth
December 30, 2021

I have been waiting for Vanguard's Superannuation Fund. If Vanguard is not investing passively, but is pursuing an agenda to vote on behalf of shareholders to reshape the way they see it should be, this is against Bogle's original objectives. (In addition those doing the reshaping are unnecessarily employed to do so given that companies must follow domestic legislation). I believe some of the issues taken into account by these 'passive' managers will prove short-sighted and add to costs. I also believe funds are incorrect when they assume shareholders are overwhelmingly interested in virtue signalling; more likely they are appealing to a noisy minority who have minimal amounts to invest. 

Pablo Berrutti
May 27, 2021

Picking one at random, the Vanguard Global MSCI ETF holds 1,529 companies. How can any organisation be an effective steward for that many companies? https://www.vanguard.com.au/personal/products/en/detail/8212/portfolio It's not to say that Lisa isn't correct that passive investors are stuck in companies and so should see stewardship and engagement as a powerful levers, but there are degrees to what can be achieved. However, even with huge portfolios investors can vote, and unlike engagement, everyone can see the results. Unfortunately for passive funds, commitments have not translated into action. https://www.reuters.com/article/us-usa-funds-index-climatechange-idUSKBN1WN105

Trevor
May 30, 2021

Maybe we are moving to a situation where investing in a vanilla index fund is the only way to avoid the virtue signallers and financial elites using other peoples money to undertake their personal crusades? The index funds still have the runs on the board when it comes to long term net performance and there is not yet any credible evidence this is likely to change.

 

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