Rise of passives risks diminishing shareholder influence

Three-fifths of European institutional investors expect the rise of passive investment vehicles to have a negative impact on shareholder engagement, reported the latest paper in the Hermes Investment Management Responsible Capitalism survey.

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Leon Kamhi, Hermes Investment Management’s head of responsibility and author of the paper, said: “Sixty percent of the investors we surveyed believe the growth of low-cost passive management will cause large shareholders to become distanced from many of the companies they invest in. However, if anything, passive investors should engage more, not less. Engagement is the only tool passive investors have to improve the value of the companies they invest in.”

The most recent Investment Association’s ‘Asset Management in the UK 2014-15’ report shows passives have increased their share of the UK market since 2008 and institutional investors are increasingly considering smart beta strategies as part of their investment mix. 

Although 71% of respondents believe that institutional shareholders have an ethical fiduciary responsibility to challenge companies with poor environmental, social and governance practices, 21% believe it is not an issue. Kamhi said this is troubling: “Whenever there are poor ESG practices that lead to the destruction of value, investors have a fiduciary duty to speak up.”

Kamhi believes if investors are to be responsible owners they need to engage – and not just with company management, but also with public policy makers as well: “If we can achieve something at a public policy level, it has a ripple effect on the whole industry. Pension funds are universal investors invested in thousands of companies across all sectors of the economy, so they are less interested in how, say, AstraZeneca is doing compared with GlaxoSmithKline, and more concerned with the health of the entire pharmaceutical sector. This is particularly relevant for passive investors who are exposed to an entire index and not only the best performers.”

The survey showed that institutional investors are still to be convinced of the merits in performance terms of a focus on ESG issues with just 46% of investors saying it can better long-term returns for investors. However, research from Hermes Global Equities found that well-governed companies tended to outperform poorly governed companies by an average of over 30 basis points per month over a five year period, while a study by the Smith School of Enterprise and the Environment at Oxford University and Arabesque Partners shows that there is “remarkable correlation between diligent sustainability business practices and economic performance”.

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