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Academic research questions effectiveness of index funds' stewardship


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Source: IR Magazine, August 12, 2019 article

Andrew Holt



US passives don’t tackle contentious management issues, reveals research

aug 12, 2019

Report also finds that index funds do not engage with management at all

In a revealing piece of research, US passive managers vote against management at companies less frequently than their actively managed counterparts when it comes to contentious issues such as executive pay.

The assertion, in the report from University of Utah academics Davidson Heath, Daniele Macciocchi and Matthew Ringgenberg and University of Geneva’s Roni Michaely, is that passive managers are not as likely to hold companies to account.

On this point, Matthew Ringgenberg tells IR Magazine that if a shareholder disagrees with the firm’s management, there are three options.

‘First, it can vote against management proposals and in favor of shareholder proposals. Second, it can engage with firm management and convince them to change their policies. Third, it can sell its shares.

‘Our paper examines each of these channels and we find that relative to active mutual funds, index funds are weak monitors that cede power to firm management. Compared to traditional active funds, index funds are much less likely to vote against firm management. 

‘They are also much less likely to sell their shares when they disagree with firm management. Finally, we find no evidence that index funds change the behavior of firm managers by engaging with them privately.’ 

In addition, across a variety of tests, the report finds no evidence that index funds engage with firm management at all.

Ringgenberg adds: ‘We find that index funds are less likely to vote against management or sell their shares, but theoretically it is possible that index funds could engage with corporate managers in other ways to make sure their preferences are represented. 

‘We examined several tests to look for evidence of this, and we find no evidence they are doing this. For example, when a fund owns more than 5 percent of a stock, the fund must disclose this with either SEC form 13D or form 13G. Form 13D allows the fund to engage with the firm to change policies, while form 13G does not. We find that index funds never file a Schedule 13D with the SEC which signals that they do not intend to affect firm policies.’

The report therefore suggests that the rise of index investing is shifting control from investors to firm managers. ‘Index funds have been a great innovation in many ways, and there is no doubt that they have benefited investors,’ says Ringgenberg.

‘However, our research shows that index funds are potentially changing corporate governance. Investors are supposed to monitor a firm’s management to make sure they are doing their job, yet index funds do not have the same incentives as traditional active funds. 

‘Because index funds charge low fees and do not try to beat the market, they do not have incentives to improve managerial behavior. Our research shows that this is giving management more control over the firm. Put differently, investors are giving up some of their control in the firm.’

In this way it could well be leading to a long-term shift in management monitoring, influence and control, as index funds have grown tremendously over the last two decades – and the trend is continuing. 

‘The big three index fund families are now responsible for around one quarter of all votes in S&P 500 firms,’ says Ringgenberg. ‘Our research highlights the importance of the link between index funds and corporate governance. The rise of index funds is changing how US corporations are managed.’


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