Passive asset management houses have enjoyed rapid growth over the past years. As a reminder, passive management describes the management of assets with the aim of tracking an index and achieving returns that reflect the return on the benchmark index. Over the last years, investors have increasingly chosen to invest in those cheaper index funds instead of alternatives managed actively in an attempt to beat the market with higher fees charged for the expertise.
As passive funds are expanding their market share, there are growing concerns that it has led to large corporations facing less scrutiny from their shareholders.
These concerns have been raised, among others, by the Scottish Investment House (which focuses on active management): “active managers like ourselves are getting increasingly involved in corporate governance issues trying to encourage business to invest for the long term. That pressure would be reduced by a move towards passive”.
Indeed, it appears that passive managers have no incentives to push companies to behave better (scandals, corporate rows…), as index funds are by definition investing in the companies they track.
The main fear is that there would be a weakening of corporate governance pressures by the rapid growth of passive investing, as raised by Old Mutual Global Investors (a UK asset manager that only sells actively managed funds): “if more and more of the industry is owned by passive investors who are only trying to replicate the index, there is no oversight. There is no governance”.
It seems that the voting patterns of large passive fund houses reflect a certain leniency regarding corporate governance: “the voting makes it look like they are management-friendly”, according to Moody’s investors’ services.
Despite these critics, some of the largest passive houses try to refute those accusations. For instance, Legal and General Investment (UK’s largest fund manager) and Blackrock (the biggest providers of index-tracking funds) have declared that they take corporate governance seriously and have increased their corporate governance resources.
State Street for instance declares that they are policing the 9000 companies it has invested in but concedes that it can’t control all the companies it is invested in.
The Executive director of MSCI (index provider) also denounces those fears over passive investing: “passive investing doesn’t mean being a passive owner. BlackRock, State Street and Vanguard are in fact among the most visible voices in corporate governance today”. He adds “given that they cannot sell positions as long as they remain in an index, there is a clear incentive to monitor governance risk on an ongoing basis and to engage with issuers. It is a fallacy to link passive investing with complacency”.
Read the Financial times articles here