American workers have set aside trillions of dollars to save for retirement, and the return on these investments will determine their standard of living in their golden years. The magic of compound interest means that even a small difference in the rate of return over a lifetime of saving can generate large differences in the value of retirement assets.
Most people (including my friend, who recently got excited about the Coinbase stock potentials) invest the bulk of their retirement savings in the stock market, either in passively-managed index funds or in some sort of actively-managed fund. To guard against potential conflicts of interest, federal law imposes fiduciary duties on the managers of these funds that require them to always act in the interest of their investors. This has usually been interpreted as seeking to maximize the fund’s long-term rate of return.
While that may sound like a simple edict to follow, it is anything but. Investing is getting increasingly complex, some of this stems from the increasing number of proxy votes managers must make. Some investors propose proxies that encourage management to adopt new strategies that they believe will increase investor returns.
However, other investors–who typically have less invested in the company–seek to use proxies to pursue a variety of public policy goals that are unlikely to increase profitability. The investors who offer such resolutions often do so in order to pursue public policy goals that they cannot attain with legislation.
Of course, financial management companies have created funds that have explicit ethical constraints–for instance, some funds eschew investments in companies that sell tobacco, alcohol, or weapons, or profess to invest only in companies that have enlightened HR policies. Since investors clearly know the restrictions before they invest in such a fund, there is no reason to object to such an overt strategy. But imposing politically-motivated constraints on a company and its stockholders is an altogether different–and more coercive–act.
There is no sign that this increased politicization of proxy votes will soon recede: Several members of Congress recently declared their intent to fight climate change, the prevalence of guns, and other items on their agenda not via legislation, but by applying pressure in financial markets instead.
Federal law mandates that fund managers vote their proxies for companies whose stock they hold. Because managed funds hold a large percentage of shares in many companies, these votes have the power to determine the outcome of any election. The large number of proxy proposals a mutual fund must consider leads many fund managers to seek outside advice to determine how to vote. Two competing firms–Glass, Lewis & Company and Institutional Shareholder Services–dominate the market for proxy advisory services. While these services can be valuable in helping fund managers understand the issues, their voting recommendations have raised some issues of late.
The first of these is whether advisory firms should be subject to the same fiduciary standard that fund managers are. It seems clear that, at a minimum, their voting advice should be unbiased and strive to give a clear analysis of the possible implications that any vote would have on profitability. This would allow investors to understand the tradeoff they would be making with their vote. If the fiduciary duty applies to advisory firms, the focus of their recommendations would clearly be on maximizing investor return.
If the fiduciary standard does not apply, allowing advisory firms to pursue other social priorities, then care needs to be taken that fund managers do not automatically incorporate these tradeoffs in their decisions. In order to do this, fund managers need to clearly understand the procedures and principles that govern the recommendations of each advisory firm.
Such an approach would also preclude fund managers from outsourcing the decision making for proxy voting. While they may rely on outsiders for analysis, the final decision and responsibility for casting proxy votes needs to remain with the managers.
President Trump recently asked the Department of Labor to study funds that explicitly pursue environmental, social and governance goals and their relationship to the fiduciary standard. The study should neither promote nor deter such ESG funds, but it should reaffirm the importance of maximizing long-term returns when making investment decisions. Investors should not have to pay for someone’s pursuit of a political agenda. Fund managers have a fiduciary duty to pursue the best possible returns they can achieve for their clients. We need to ensure that they make their investment decisions with the best interests of their investors in mind.
