Are you concerned about climate change, or about social issues such as corporate board diversity? Can you as a shareholder have your preferences communicated to company management and perhaps impact corporate policy on these issues? For the majority of individual investors, the short answer is “no.”
That’s because most individual investors own mutual funds. But the structure of the mutual fund makes it difficult to reflect shareholder objectives and values related to environmental, social, and governance (ESG) issues.
The growth in individual shareholder ownership ironically has created a huge gap in corporate governance and accountability. The ownership of Corporate America lies largely with employees through 401(k) plans and other retirement vehicles, except these same employee-owners cannot and do not have proxy voting rights — these are exercised by the fund providers.
Given the size of retail assets that fund managers control — collectively close to $10 trillion — there is a valid concern about their voting practices not reflecting the preferences of the millions of investors in their funds. A typical fund has to vote on hundreds of proxies each year, most of them routine. The voting process is centralized and fairly automated, with default guidelines regarding how the shares are voted. The fund manager conducts analysis only on issues that materially impact a company’s financial or operating performance, and then casts a vote.
Having managed mutual funds for a long time and voted hundreds of proxies globally, I believe there is a simple and direct way to reflect shareholder ESG preferences in the voting of proxies: Through the fund prospectus.
The seismic shift from active- to passive investing through index funds and ETFs has exacerbated this issue. Passive assets outnumber actively managed assets, and the trend shows no sign of abating. An index fund’s mandate is to track a specific index, so the index fund manager has even less incentive to actively vote proxies.
Acknowledging that shareholders have strong preferences, particularly with regard to a key issue like climate change, means that boards should not have a uniform voting policy across funds, even if they are index funds. The other policy implication is that every 401(k) plan should offer its participants an ESG index fund. As of March 2017, 401(k) plans held $5 trillion in assets; the vast majority of these plans do not offer their participants an ESG option. An ESG target date fund (TDF) would allow 401(k) plan participants to allocate their portfolios towards ESG in a cost-effective manner.
I propose a new type of fund that would blend elements of existing ESG investment vehicles: an index fund structured to track a broad market index, such as the S&P 500 SPX, +0.10%. In addition, the fund will state in its investment objective that the adviser will follow a clearly articulated proxy voting policy.
Read the full post at MarketWatch
Gita R. Rao is a Senior Lecturer in Finance, and Associate Faculty Director of the Master of Finance program at the MIT Sloan School of Management.