February 2, 2017 Engaging with passive investors – index fund holdings have found their voice…make sure you don’t ignore it

By Bruce H. Goldfarb

The giant shift in assets from active to passive investment strategies over the last few years has profoundly changed the balance of shareholder power in corporate America. Index funds managed by investment giants such as BlackRock, Vanguard, and State Street are now more influential than ever. These investors not only own a larger share of US and international companies than ever before, but are also becoming increasingly vocal about corporate governance, executive compensation, and other vital investor issues.

While companies tend to be primarily concerned, from a defensive standpoint, with activist hedge funds, company managements and boards of directors should take note of large traditional managers and rethink the way they engage with these influential, “vocal passive” shareholders.

The growing role of passive investors is undeniable. From 2008 to 2015, investors moved approximately US$1 trillion into passively managed funds. The US$4 trillion passive index fund sector is dominated by BlackRock, Vanguard and State Street. A recent paper by researchers at the University of Amsterdam estimates that collectively these three investors constitute the largest shareholders in 88% of S&P 500 companies.

Traditionally, managements and boards of directors may have been tempted to overlook these major shareholders at proxy time, given that index funds’ holdings, while substantial, are relatively stable. It was also assumed that the funds’ primarily passive investment approach implied a passive stance with respect to corporate governance and voting as well. It was almost a given that many of these shareholders would vote with managements’ recommendations or follow the advice of proxy advisory firms like ISS and Glass Lewis.

More Assertive Approach to Adding Value

As index funds’ holdings have grown dramatically, the fact that their positions are “built to last” has given them an incentive to become more assertive. These investors recognize that, while they may not be able to use the active management of investment positions to create value, they can urge companies to enhance value through more investor-friendly policies. In the past few years, this realization has led BlackRock, Vanguard, State Street and other index fund managers to express a more active – almost activist – attitude toward corporate boards. All three have issued letters to boards noting an increased focus on corporate governance. And, in 2015 BlackRock revised its proxy voting guidelines to provide more oversight in board re-elections, especially with regard to issues such as long tenures, board diversity, lack of meeting attendance, and protecting shareholder rights.

Read the rest of the article in Ethical Boardroom Magazine (PDF)