Morningstar Magazine - December 2017/January 2018 - 38

Spotlight: Abnormal Profitability

Passive Firms Take Active Approach
to Stewardship
Index funds are becoming more engaged
with investee companies.

ENGAGEMEN T

Hortense Bioy

As assets continue to flow from actively managed
to passively managed strategies, the largest
index asset managers1 are becoming increasingly
influential, often ranking among the largest
investors of public companies. Despite this fact,
little research has been done to understand
how index managers carry out their investment
stewardship responsibilities.
It is legitimate to assume that index managers
have little incentive to allocate resources
to monitor corporate governance of investee
companies, because, after all, index
managers tend to compete on fees, and their
overriding objective is to match the performance
of indexes. Our research shows, however,
6000
that the notion
that these managers take
a laissez-faire approach to governance could not
5000
be further from
the truth.

4000 the stewardship activities
To better understand
of index managers, we surveyed 12 of
3000
the largest providers of index funds and exchangetraded funds across the United States, Europe,
2000
and Asia ( E X H IB IT 1 ). These include not only global
asset managers
such as BlackRock BLK and
1000
Vanguard, but also smaller firms that are key
providers of passive
0funds in their local markets,
such as Charles Schwab SCHW and Lyxor.
Collectively, the firms surveyed have more than
$20 trillion of assets under management.

Large asset owners have led the push for
increased oversight, as more and more believe that
ESG integration and active ownership practices-
through voting and engagement-can
have a positive impact on investment performance.
Regulators have contributed further with the
adoption of stewardship codes in several countries,
including the U.K., Switzerland, and Japan.
Another factor fueling the change in behavior
among index managers is the tremendous growth
of the assets they manage. Assets in traditional
index funds and ETFs have grown fourfold
since the financial crisis and now account for close
to one fourth of total fund assets globally,
according to Morningstar data.

Our research shows that the shift to passive
investing hasn't led to an abdication of
stewardship responsibilities. Quite the contrary.
Index managers are increasingly taking
an active stance in the oversight of investee
companies. They are more committed than
ever to using the tools at their disposal, chiefly
voting and engagement, to improve the
environmental, social and governance, or ESG,
practices of companies.

Perhaps the single most compelling piece
of evidence of the increased commitment to active
ownership practices among index managers
is the growth of their investment stewardship
teams. For example, BlackRock expanded its team
from 20 members in 2014 to 33 today; Vanguard's

20
EXHIBIT 1

On Stewardship We surveyed 12 of the largest index providers worldwide about
their engagements with investee companies.
Surveyed Managers With Total AUM Split Into Passive and Active Assets

Actively Managed Assets

Passively Managed Assets
$6,000B

1,938

5,000
1,170

4,000

3,762
3,270
548
2,062

3,000
2,027

2,000
1,185

BlackRock Vanguard

SSgA

319
Fidelity

89
Amundi

665
580
LGIM

687
121
Deutsche
AM

460
270
UBS
AM

233
162

183
139

123
61

71
71

Nomura
AM

Charles
Schwab

Nikko
AM

Lyxor

1,000
0

Source: Asset manager data. Data as of 06/30/2017.

1 Throughout this article, we use the term index managers to refer to asset managers who provide index-tracking investments, including traditional index funds, ETFs, and segregated mandates.

Morningstar December/January 2018

Table of Contents for the Digital Edition of Morningstar Magazine - December 2017/January 2018