The CFA Institute Annual Conference is an unrivaled opportunity to access high-quality, unbiased educational content that equips investment professionals with the latest thinking on critical industry issues. The 70th CFA Institute Annual Conference will be held in Philadelphia on 21–24 May 2017.
How can investors use their skills to improve the firms they invest in? Rakhi Kumar, managing director and head of corporate governance at State Street Global Advisors, spoke to delegates at the 69th CFA Institute Annual Conference in Montréal about the approach she and her team use to engage with companies in their portfolio and the trends that she sees in investor engagement. Kumar believes it is important for long-term investors to encourage long-term strategy at companies and for all investors to recognize the role they play in markets.
Activism vs. Engagement
Activist investors have been controversial, alternately viewed as good checks on the quality of company management or as hostile foes intent on creating short-term value at the expense of long-term strategy. In fact, A recent poll of CFA Institute Financial NewsBrief readers found a divided opinion over activist investing and whether it has positive effects on the financial system.
What are the warning signs that management may not be aligned with the long-term investor? Kumar says that when executive compensation becomes tied to earnings per share, it reflects a big change in priorities and strategy for a firm. Instead, the firm should be evaluating its performance in the same way that the market will when determining its long-term prospects — namely, sales, revenue, and margins. Often, short-term cost-cutting measures must be addressed later in a more costly way.
Kumar prefers to engage with company management in a discussion of how different risks are managed within the company’s strategy and to prompt them to make changes on their own. When a vote against management is required, it reflects a failure of engagement. When asked if she would work with activist investors, however, she replied that she would consider working together. “I will always take a call from someone who wants to create change,” Kumar said.
Prioritization of Issues
Given the sheer number of proxy votes, even a large firm like State Street must prioritize its involvement and use technology to be efficient. Kumar uses a risk-based approach based on the size of the holding and its impact on the portfolio. She also described the difference between value- and values-based investing and how it impacts scalability. For example, if you use a standard rule (a values-based approach), such as “the CEO and chair roles should be separate,” it can easily be applied across firms. The value-based alternative would be to evaluate how and if it matters in each situation.
Smaller firms may outsource these decisions to proxy services firms, or they may become free riders benefiting from the work of large organizations. This doesn’t deter Kumar, and she thinks competitive forces will prevail. Still, she urges all investment professionals to raise issues when they encounter them. Most companies will listen to investors, she says, but investors must also be clear about what they want.
The Future of Stewardship
Kumar identified the following 10 trends that will shape the landscape going forward.
- The growing influence of passive investors: Traditionally, companies have ignored passive investors because these investors have no choice but to follow the market weighting in the index. Today, as passive investing has grown, organizations like State Street represent a growing proportion of shares and the voting rights with them. Kumar takes an active approach to engagement with companies despite their passive mandates, and they cast all their votes the same way, so these are meaningful blocks.
- The rise of environmental, social, and governance (ESG) investing: Kumar describes these as low-probability, high-impact factors, and they matter more in a long-term investing environment. Identifying key risks is important, and we need consistency in their identification and the methodology for calculating them; Kumar suggested that CFA Institute and its members can play a role in this.
- Climate issues: These have become a growing topic of discussion over the last two years, with 189 climate proposals in the United States. State Street recently published a Climate Change Risk Oversight Framework for Directors.
- Scope of fiduciary duty: Consideration of ESG factors is now seen as work that fiduciaries should do in proper analysis. Previously, ESG considerations and fiduciary duty were considered by some to be in conflict.
- Reputational risk: This has become an increasingly important consideration for companies, especially around ESG matters.
- Global differences: Company engagement will continue to evolve in developing markets. Currently, there are many countries where ownership structures preclude active investor involvement. In the meantime, firms can work with regulators to address macro issues at the country level.
- Empowered and accessible directors: Direct engagement with directors is helpful because there is a risk when going through management that messages are filtered. In the United States, directors are more empowered today than they have ever been before, and they are much more accessible to investors, with a more open approach.
- Companies resisting engagement: This disturbing trend does not benefit investors; companies are starting to settle with activists because they don’t want to engage. In some cases, it is easier to just give up a seat at the table.
- Increased reporting on investor engagement: Firms like State Street are reporting in annual stewardship reports on their activities by listing their voting record and engagements with companies. This will provide greater transparency to the market.
- Integrated corporate governance: The organizational placement of corporate governance analysts in an investment firm impacts the approach to governance. Although the governance function sits within the compliance area in many firms, Kumar is on the portfolio management team; she meets with companies alongside these colleagues, allowing for better integration of governance into the investment decisions.
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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.
Photo courtesy of W. Scott Mitchell