Fund companies, in no-win situation, test shareholder proxy voting

I’m willing to bet most retail investors don’t understand enough about proxy voting to know if they should even care about the myriad boardroom decisions at the companies they own through mutual funds and exchange-traded funds.

That’s actually part of the beauty of owning funds instead of individual securities. As a regular investor just trying to prepare for retirement and maybe save enough to send a kid to college, you’re a step removed from the responsibility or hassle of proxy voting.

But those days of blissfully ignoring the dozens of corporate-level policies and shareholder proposals at each of the hundreds of individual companies an average investor might own are fading fast.

The emerging trend among the country’s largest asset managers of testing ways to give fund investors more say in the proxy voting process is a bell that can’t be un-rung.

BlackRock, State Street, Vanguard and Schwab have each undertaken pilot programs that will let fund shareholders weigh in on how the shares of the underlying companies in those funds are voted on proxy issues.

At Vanguard, for example, investors in three popular index funds can choose from four preferences on how they want the fund company’s proxy committee to vote on proxy matters for the 25 largest holdings in those funds.

So far, no fund company is passing along individual proxy votes to every fund shareholder, and every fund shareholder should be grateful for that.

Shareholders in Vanguard's pilot program can choose between letting Vanguard do whatever it has always done regarding proxy votes, vote with the underlying company board, abstain from voting the investor’s shares, or vote in line with the direction from third-party proxy advisors.

Each fund company’s program is unique, but they all try to offer shareholders a chance to participate in the proxy voting process, while assuming there’s enough interest to make it worth the effort. That’s the unanswered question right now.

None of these programs has been around long enough to provide any kind of useful gauge of success.

At Schwab, which was first out of a gate when it announced a pilot program for retail investors in October, shareholders in three funds are sent a list of 10 questions that will help Schwab decide how it votes.

The list of questions is also sent to any new investors in those funds during the 12-month pilot period, and if shareholders don’t respond to the initial outreach, Schwab will send out at least one follow-up to encourage participation.

“We want to gauge what our shareholders care about, and that can help inform what we’re doing, because we don’t want to take one side of this debate, we want to provide options,” said David Botset, head of equity product management and innovation at Schwab Asset Management.

While attempting to gauge what shareholders care about, Botset admits nobody knows if shareholders will participate in large enough numbers to make it worth the effort.

From the average shareholder’s perspective, it’s difficult to see the downside of including more views and input on proxy votes. But like a lot of things these days, this trend appears to be driven by small minorities with the loudest voices that are fueling populist campaigns.

“The proxy push has become a political football, and I don’t think investors care at all about voting proxies,” said Eric Balchunas, ETF analyst at Bloomberg Intelligence.

He acknowledges the lopsidedness of examples like BlackRock and Vanguard, through their respective funds, owning a 15% voting share of a majority of U.S. companies. But Balchunas is also in the camp that the proxy vote programs might be for naught if shareholders don't participate.

And even if they do vote, it’s not clear the fund companies will go far enough to appease those loudest voices clamoring for change.

A lot of the momentum behind the proxy focus can be traced to ESG investing and other forms of shareholder activism that is fueling political divisions throughout financial services.  This increased focus on proxy voting at the shareholder level is that and more, which is why it isn’t going away.

Balchunas believes fund companies are in a no-win situation as populist movements drag them into what's becoming a political battlefield.

For example, on the one hand you’ve got BlackRock Chief Executive Larry Fink flying around the world on private jets telling corporations to lower their carbon footprints; on the other, there’s the reality that fund companies, including BlackRock, vote with the management of their funds' underlying companies 90% of the time.

“If you gave Larry Fink a time machine, I think he would go back and undo what he’s said about all that stuff,” Balchunas said.

So here we are, watching fund companies cautiously wade into the uncharted waters of retail investor proxy voting and likely strategizing ways to dodge the inevitable crossfire.

We can assume the pilot programs will expand and perhaps become more granular, enabling the fund companies to check a box showing how much they value shareholder feedback and all that jazz.

But as far as shareholder participation goes, my money is still on the side of apathy because most investors are still separating valuations from values.