Markets Insight
September 19, 2012 1:20 pm
Fund managers must break their silence
While it has been little remarked on and even less analysed, the nature of stock ownership has experienced a sea change since the second world war. Ownership of US stocks by financial institutions has leapt from 8 per cent to 70 per cent. A similar trend has prevailed globally.
US financial institutions – mutual funds, pension funds, endowment funds, and bank trustees – hold more than two-thirds of the shares of virtually every publicly held US corporation, giving them total voting control.
The ownership is concentrated among a few giant money managers. Of the $9tn of stocks held by the 300 largest US money managers, some $6tn are held by the 25 largest managers. The five largest firms alone – Vanguard, BlackRock, State Street Global, Fidelity, and American Funds – hold almost $3tn, or fully a third of that total.
Remarkably, these giant firms have been conspicuous by their absence from exerting significant influence on the companies that they collectively own. “The silence of the funds” has been, well, deafening. In the proxy process, these managers overwhelmingly support existing boards of directors and management pay plans, rarely giving strong support to shareholder proposals on remuneration. I know of not one of these big managers that has submitted a proxy proposal in the face of management opposition.
In 2003, when the Securities and Exchange Commission proposed to facilitate more access to the then essentially closed participation in the proxy process, no large fund manager called for greater access. In fact, several managers actually argued for more stringent limitations.
Part of the reason for this “hands-off” attitude is that the stock market is dominated by short-term speculators. These “renters” of stocks don’t give a hoot about governance. But how does one explain the hands-off attitude of long-term investors, “owners”, and especially index funds with essentially infinite time horizons?
The answer has to do with three factors. First, a profession that focused on stewardship and investment management has become a business focused on salesmanship.
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Governance activism attracts attention and controversy and has no marketing value. It probably has negative value, impeding the asset-gathering goals that money managers hold pre-eminent.
Second, the ownership of these large money managers has become dominated by groups that are publicly held. Such fund managers are duty-bound to serve the fund shareholders and pension beneficiaries by optimising the return on their capital. They also have a duty to serve their public shareholders, largely giant conglomerates in business to earn maximum returns on their own capital – a clear conflict of interest and a violation of the Biblical warning “no man can serve two masters”.
Third, the money managers owe their profitability largely to the giant corporations whose retirement plans they manage. There seems little interest in “biting the hand that feeds you”. As it is said, there are only two kinds of clients money managers do not want to offend: actual and potential.
Today, the silence of the funds is particularly troubling. For both of the major issues that confront our corporations are slanted in favour of managers rather than owners. One issue is executive remuneration. This deeply flawed approach results, in part, from a system that focuses on peer remuneration rather than corporate performance, producing “a ratchet effect” year after year.
Management remuneration is based on raising the short-term price of the stock, labelled “increasing shareholder value”, rather than building intrinsic corporate value over the long term. What’s more, corporate executives get away with murder, figuratively, with pay plans that kick in without requiring a certain return on capital.
The second issue is corporate political contributions. While the demand for full disclosure of political contributions is growing, mere disclosure doesn’t go nearly far enough. Corporate shareholders should have the right to decide if their corporations can make any contributions. But our corporate managers have no interest in facilitating corporate democracy and our institutional owners even less interest in exercising their voting rights.
It is time for fund managers to honour the rights of, and assume the responsibilities for, corporate governance. Institutional investors must break their long silence and make their own proposals for inclusion in corporate proxies. These steps toward greater activism in corporate governance by our giant investor/agents, who are fiduciaries for their shareholder/principals, are essential to sound long-term investing, to our system of modern capitalism, and to the national interest. The mutual fund industry should be in the vanguard of this movement.
John C. Bogle is founder of US fund manager Vanguard and author of The Clash of the Cultures: Investment vs. Speculation
Copyright The Financial Times Limited 2012.
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