Passive managers are getting very active
ETF issuers are becoming an increasingly powerful force inside company boardrooms.
Summary: Exchange-traded fund product issuers have amassed large shareholdings across the ASX 200 and beyond, and they are not afraid to flex their voting might when they have to. The biggest funds have active investment stewardship teams who regularly arrange meetings with senior company management to ensure their interests are being served.
Key take-out: ETFs are taking a strong interest in corporate governance structures, and in evaluating companies on the functioning of their board, its composition, independence, diversity, experience, and so good risk management strategies and systems are in place. Those that miss the mark can expect a call.
Australian shareholders will soon be gathering in their droves, some inside large auditoriums, as the bulk of our largest companies put on their annual general meeting events.
The boards of most of the top 200 companies on the ASX will take centre stage between mid-October and December, giving investors the opportunity to address questions, voice concerns and vote on resolutions including director appointments, executive remuneration and capital raisings.
But, for all intents and purposes, the heavy lifting for investors will have already been done well before the AGMs, thanks to the world's biggest institutional shareholders.
They include BlackRock, Vanguard and State Street, which have billions invested in the Australian share market through holdings in hundreds of companies. Collectively they control more than $US15 trillion in funds under management globally, and rank as the top three passive investment houses in the world by virtue of their domination of the huge index-tracking exchange-traded funds sector.
Yet, the ETF product giants are anything but passive when it comes to protecting their investment interests. Each have very active “investment stewardship” teams that, unlike small shareholders, have enough financial clout to open boardroom doors. When a major customer knocks, it usually pays to answer.
Pru Bennett, who heads up BlackRock's Asia-Pacific investment stewardship team from Hong Kong, says direct engagement at the board level is important to ensure companies are adhering to the highest corporate governance standards and essentially making good decisions.
Along with members of her team, Bennett visits Australia five to six times a year to meet with the chairmen and chief executives of Australia's largest listed companies.
“It's important we build a relationship with those boards, because we are long-term shareholders and selling is not an option, unlike an active manager,” she says.
Vanguard Group chairman and CEO Bill McNabb drew on the same long-term perspective when he penned an open letter to thousands of public company directors worldwide at the end of August, thanking them for their role in overseeing his firm's “sizeable investment” in their company.
“At Vanguard, a long-term perspective informs every aspect of our investment approach, from the way we manage our funds to the advice we give our investors. Our index funds are structurally long-term, holding their investments almost indefinitely.”
McNabb added that Vanguard's evaluation of company corporate governance practices focused on the board, including gender diversity, governance structures, appropriate executive remuneration and risk oversight.
“Our focus on corporate governance and investment stewardship has been and will continue to be a deliberate manifestation of Vanguard's core purpose: ‘To take a stand for all investors, to treat them fairly, and to give them the best chance for investment success'.
“As essentially permanent owners of the companies you lead, we have a special obligation to be engaged stewards actively focused on the long term.”
Like all long-term relationships, sometimes there can be rocky patches, especially when it comes to voting.
“We are a substantial shareholder in a large number of ASX 100 companies and, when it comes to voting, we are obviously voting at all their annual meetings,” Bennett says.
“We have a policy of engaging with a company before we vote against any particular proposal, so there are no surprises for the company. And I think that's responsible given some of the sizes of the holdings that we have.”
Even still, data from BlackRock shows that in the year to June 30, the fund manager voted against one or more management recommendations at 37 per cent of the annual company meetings it participated in globally over the year. BlackRock voted on more than 53,000 company proposals in the Asia-Pacific region alone last financial year.
“Our starting position is generally to support management, engaging where we have concerns that the board or management might not be acting in the best long-term economic interests of shareholders such as our clients,” the firm states.
“We will vote against a company's proposal if we believe that the issue under consideration is clearly not in our clients' economic interests, the company does not wish to engage with us or engagement fails to resolve our concerns.”
Shareholder activism is certainly nothing new in Australia, but it is on the rise.
US hedge fund Elliott Management has been on the attack against the board of BHP Billiton since earlier this year, castigating management over the company's underperformance against its peers. That stems from a long line of questionable asset purchases, including the company's $US20 billion investment in US shale assets in 2011, and further investments of $US20 billion into the same assets, followed by a string of heavy write-downs.
With a 5 per cent stake in BHP's UK-listed shares, it's expected that representatives of Elliott will turn up to the “Big Australian's” annual meeting at Margaret Court Arena in Melbourne on November 16.
They'll be joined by other substantial key stakeholders, including representatives from BlackRock, Vanguard, State Street and other large fund managers holding swathes of BHP stock.
BlackRock's Bennett says that as a major shareholder in so many Australian companies, having a long-term investment approach is imperative.
“We are a patient investor and we will work with companies to try and influence change that will have an impact over the longer term,” she says.
Bennett notes that on a global scorecard basis, Australian companies are doing quite well in terms of good corporate governance structures, and in tailoring executive compensation packages that are more aligned to operational outcomes rather than just share performance hurdles or accounting measures.
But having longer-term outlooks is still a work in progress for many large companies.
“I pick up the average annual report from the ASX 200 companies. Very, very few, when you read the chairman's statement or the CEO's statement, are really talking about the long term beyond six months.”
For smaller shareholders, the looming AGM season will most likely be the one and only opportunity this year to grill directors over the company's performance, the CEO's pay package, and to perhaps ask them for a longer-range view than just the next six or 12 months.
Of course, voting on company resolutions, such as board appointments, pay increases and other business, will also be on the agenda. But sadly, the outcomes for each resolution – one way or the other – will rest in the hands of the major shareholders, including the institutions.
Don't despair. Annual meetings are usually entertaining, and there's always that free cup of tea and a biscuit at the end.
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