More than $413 billion flowed into U.S.-based passive funds in 2015, according to Morningstar Inc., raising questions as to whether those passive investors can have sufficient influence on the companies receiving their capital based simply on their inclusion in an index.
Three academics — one from Boston College and two from the Wharton School, University of Pennsylvania in their 2014 research paper “Passive Investors, Not Passive Owners”— show how investors' interests are unquestionably being represented aggressively by passive fund managers.
I agree, and say the influence gap can be bridged as long as passive managers get active on behalf of their investors and in the interests of long-term value creation.
Unlike active managers who can sell companies when they disagree with management, passive managers represent near permanent capital that cannot vote with its feet — as long as a company is included in the index it remains in the portfolio. But that long-term ownership requirement actually enhances influence and perspective.
As passive flows grow, managers have a distinct responsibility to become long-term asset stewards and actively engage with companies in the index across a range of important governance and sustainability issues that are key to generating value over the long run.
But how can passive managers make a difference when they are required to own every stock in the index? The most effective way to create meaningful change is to build a thoughtful engagement program with a focus on sector, thematic or market-specific issues that can scale across multiple companies. Managers can identify companies for active engagement based upon criteria such as the size of holdings; poor long-term financial performance within a sector; lagging market and industry standards; or priority themes and sectors according to emerging environmental, social or governance risks. However, they must also be prepared to use their voting power to reinforce value priorities with clearly articulated rationales if engagement falls short.