CLS Blue Sky Blog

How to Restore Shareholder Agency With Pass-Through Voting

Sign up for an investment account, and you will likely be presented with a dizzying range of investment products. The industry caters to investors with different risk appetites, savings pots, time horizons, ESG outlooks, religious commitments, and more. In some cases, a single firm will offer this variety across hundreds and even thousands of funds.

But when it comes to shareholder voting, the industry has been slow to present investors with the same level of choice. Until Vanguard launched its voting-preference pilot, retail investors had never been offered a say in  how their fund investments were voted. Institutional firms invested within pooled funds also had no choice: Until BlackRock launched “Voting Choice,” they were forced to follow BlackRock’s house policy, even on high profile votes they openly disagreed with. Both firms have launched what we call “pass-through voting,” which enables investors in pooled funds to cast proxy votes on a pro-rata ownership basis, where previously the entire pool would be voted by the fund manager, usually in one direction on behalf of all funds and investors across the firm. Investors have responded positively, though some critics have warned of added costs. Harvard Law School Professor John Coates, for example, said pass-through voting’s  implementation costs would far outweigh its  potential benefits. However, modern software and improved custodian efficiency have reduced the cost, and potential benefits are in any event subjective and yet to be fully felt.

Yet most important, voting is essential to investing and being a shareholder, and clients should have a right to it – whether or not they use it – no matter the investment structure.

A Matter of (Fiduciary) Duty

Pass-through voting allows investors to reclaim voting from their fund managers. But why, when fund managers have a fiduciary duty to act in the best interests of the fund, would investors what to do that? The answer lies in the differing definitions of best interests.

For many fund managers, the default best interests strategy is to maximize shareholder value because it is what most shareholders would prefer. Yet  investors have a great variety of priorities. As Caleb Griffin, a corporate governance academic, puts it, “There are some important problems with the ‘best interests’ standard. The first question begging to be answered is, whose best interests? One hundred percent of investors? Fifty-one percent?”

Professors Jill Fisch and Jeff Schwartz expand on that argument, saying fund managers have a fiduciary duty to seek out beneficiaries’ preferences to ensure their voting reflects beneficiary interests. This argument seems especially relevant given the increasing divergence of investor views on ESG.

These requirements may seem contrary to many active fund managers’ goal of aligning voting with an individual company’s aim of maximizing its share price. Asset owners, on the other hand, might think of themselves as universal owners – invested in one fund alongside many others and ultimately across thousands of securities. They might be less interested in individual company performance and more interested in the performance of their diversified portfolio. Your view of pass-through voting will likely depend on how you approach that question.

The fact is that voting is nuanced and often subjective. Fund managers may not be able to reflect investor preferences even when those preferences are clear (such as when they invest in ESG-labelled funds). It becomes even more complex when you consider that whether or not investors support a shareholder proposal could depend on their time horizon, attitude to risk, personal values, or other considerations. It seems unlikely that fund managers will be able to satisfy the best interests of everyone invested in their fund unless there is more diversity in their vote offerings across funds and even within them.

Expression of Wish

Professors Fisch and Schwartz offer “informed intermediation” or, as the UK government has referred to it, “expression of wish” as the better alternative to pass-through voting. This is when investors communicate their voting preferences to managers who will “consider” them; a softer influence on voting.

Expression of wish may be an option for investors who do not want to control voting but want to be able to say they have engaged with their managers. However, as our pass-through voting white paper revealed, there is significant misalignment between fund managers’ voting on behalf of a single investor.

Expression of wish does not work when an investor wants to guarantee an outcome or improve the alignment of votes cast across their portfolio. Both asset owners and fund managers have fiduciary duties to ensure money is managed in the best interests of the beneficiaries or of the fund, but they may see and fulfil those duties differently. It is an inevitable consequence of delegation.

Considering these practicalities, expression of wish does allow fund managers to better understand the preferences of pooled-fund investors. However, as managers often submit conflicting votes, an investor will never be able to guarantee that their votes are cast in line with their investment outlook. To ensure any level of certainty, pass-through voting is required.

Voting Is a Shareholding Right

Investing has become so intermediated that a large portion of the world’s proxy votes are concentrated with a small number of very big institutions. This byproduct of the evolution of corporate law has obscured an important truth: that investing usually comes with voting rights. The result is that employees enrolled in a pension plan have no idea that their money is being invested in the companies around them; retail investors trading on a broker platform never realize that they can vote at those invested companies’ annual meetings; institutional investors invested through pooled funds feel powerless to influence the votes that their fund managers cast.

Fortunately, writers like Merryn Somerset Webb tell us that, “If we can remind people that they are all owners and convince them that they have the power to act as such (by using their votes as shareholders), we can reconnect big business and ordinary people while also forcing better behaviour on the corporate world.” [1]

Some are wary of offering such power to investors, fearing that their apathy and lack of sophistication, and access to relevant information could trigger unintended consequences. Yet pass-through voting does not  burden investors with voting on thousands of resolutions. It gives them the choice whether to cast votes where they feel they are equipped to do so. Consider the retail investor: He isn’t expected to vote on every share he owns but is entitled to cast a vote on his investments if he wants to. Personalization and policy-building tools would also allow him to curate and automate his engagement with the companies he has a right to vote at.

Given all this, why is the asset-management industry so slow to share the vote with investors? It does not come at the cost of informed decisions on corporate governance. Rather, it enriches those decisions by incorporating voices of shareholders who have so far been disenfranchised from participating in the system. It is their hard-earned money that is being used to make investments and prop up those managers in the first place.

Making a Monetary Decision

Giving investors agency over their votes is more than a philosophical endeavor — it is also about managing their money. Voting outcomes can increase or decrease a company’s value and therefore an investor’s returns.

One a vote-by-vote basis, voting outcomes evidently have a tangible impact on a company’s performance. For example, research has shown that a negative say-on-pay vote can improve a company’s pay practices by reining in executive pay packages. The power that shareholders have to influence management decisions can affect a company’s share price in an instant, clearly evidenced through board elections and votes on approving corporate mergers and takeovers. Shareholders and investors may also make decisions that shape a company’s performance more subtly, through votes on shareholder proposals that address long-term risks, such as the vote on a scenario-analysis report at ExxonMobil.

Some active fund managers have opposed pass-through voting because they view voting as an integral part of stewardship. It is useful leverage when engaging with investee companies. Therefore, they argue that voting should be retained by the manager to ensure votes align with engagement efforts. However, many fund managers already offer segregated mandates to institutional investors that can afford it, which gives them voting rights. If asset owners in pooled funds can vote, leverage is not reduced altogether, but rather moved from one firm to another – either the asset owner takes the responsibility or shares it with specialist firms that they believe represent their investment outlook and who often represent many of their peers in segregated mandates.

Clearly, shareholder voting can have an impact on a company’s performance — and therefore a fund’s investment returns. Given this link, there is a strong case for allowing investors the ability to use it for their benefit.

Looking Ahead

It is no secret that the financial industry moves at a glacial pace. Academics started advocating for pass-through voting back in 1980, and yet the first pass-through vote was not placed until BlackRock’s Voting Choice was launched in 2021, a full 41 years later. But change is coming. On top of the proposed INDEX Act in the U.S. which, if passed, would require passive fund managers to solicit investors’ voting preferences, the biggest three fund managers –  BlackRock, Vanguard, and State Street – have begun offering pass-through voting. In the UK, CIRCA5000 in partnership with Tumelo recently launched the first suite of ETFs that offer pass-through voting. Institutional investors, in the U.S. especially, have also begun to request pass-through voting from their fund managers.

Ultimately, pass-through voting is about agency: giving investors the choice whether to exercise their votes, design their own policy, follow recommendations from advisers, or delegate voting to their fund managers. Questions on how best to implement it are both valid and necessary but shouldn’t obscure the fact that investors deserve to have a say over how their votes are managed.

ENDNOTE[1] Merryn Somerset Webb, Share Power (2022), p17-18.

This post comes to us from Georgia Stewart, chief executive officer of Tumelo, a financial firm that specializes in shareholder voting.

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