For the last several years, ETFs have been the darlings of the financial world, widely praised for their ability to offer cheap, diversified exposure to nearly every corner of the market and the flexibility that sets them apart from traditional open-end funds. And while there is little debate over certain advantages of ETFs, it is beginning to seem like the honeymoon with the financial press is over, as many analysts are digging a litter deeper into the nuances of exchange-traded products and discovering that they are not without their flaws. Last week, The Wall Street Journal’s Ian Salisbury delved into the proxy voting habits of ETF firms, revealing some rather intriguing and potentially alarming patterns.
As indexing and passive investing strategies have become increasingly popular, the power wielded by ETF firms over the management of some of the world’s largest corporations has grown significantly. While the interests in these companies represent the assets of individual investors throughout the countries, it is the fund firms that maintain the right to vote in corporate elections. “Most investors donʼt know that when they buy an ETF, they also give that ETF the right to vote at all the underlying companies owned by that ETF,” says Jon Lukomnik, program director at the Investor Responsibility Research Center Institute (IRRCI), the organization that completed the study. ETF firms argue that they are best equipped to handle the voting process and represent their investors’ best interest, while some critics have argued that they’re “asleep at the switch.”
The study examined the proxy voting policies and and recent voting records of seven of the largest ETF sponsors (iShares, SSgA, Vanguard, Invesco PowerShares, ProShares, Rydex, and WisdomTree). “Our analysis revealed wide variation in both the voting policies of the seven dominant ETF sponsors, as well as how they actually voted on a sample of twenty-one specific votes on a variety of important governance and social policy issues,” said Scott Fenn, senior managing director for policy at PROXY Governance. The proposals in question ranged from executive pay at Comcast to whether to appoint an independent chairman at Exxon Mobil. Among the specific findings:
- ProShares voted with management on only five of the 21 proposals, while Rydex sided with management on 19 of them. The rest of the fund firms fell somewhere in between. As such, there is significant variation in the voting philosophies and patterns of the largest ETF sponsors, with some funds much more likely to vote against management on both shareholder and management-sponsored proposals than other funds.
|Issuer||% Votes Against Management Proposals||% Votes For Shareholder Proposals (Governance)||% Votes For Shareholder Proposals (Compensation)||% Votes For Shareholder Proposals (Social Issues)|
(Keep in mind that there is a relatively small sample size for each proposal category. Also, it is noted that Vanguard regularly abstains on social and environmental proposals)
- The three largest ETF sponsors are somewhat less likely to vote against management on shareholder proposals than are the smaller fund companies considered in the study. The three largest issuers also withold votes from incumbent director nominees at a greater number of companies than small funds. This appears to indicate that the witholding of votes is their preferred method for expressing dissatisfaction (rather than voting against management on specific proposals).
- Funds that rely heavily on a proxy advisory firm for guidelines tend to vote against management proposals (and in favor of shareholder proposals) more frequently than those that rely on their own guidelines.
Since ETF firms are often among the largest individual shareholders in individual corporations, their voting policies can have important ramifications on shareholder protection and corporate governance. If major fund firms are unlikely to challenge management on controversial proposals, it is possible that the rise in popularity of ETFs has been detrimental to investor rights. But the results of the study are far from conclusive, and they seem to indicate that many fund firms do an excellent job of voting in an informed manner that is consistent with the best interests of their investors. In short, while the IIRCI study doesn’t indicate and devastating oversights by ETF firms, it does raise a few red flags and highlight another area that investors should consider carefully when choosing between particular ETF sponsors.
View the full results of the study here.
Disclosure: No positions at time of writing.