Consumer Awareness: Shareholder rights in the new age of investing

This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on April 6, 2020 - April 12, 2020.

Photo by Haris Hassan/The Edge

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The investing landscape has changed over the past few years as passive investing products such as exchange-traded funds (ETFs) and automated platforms like robo-advisors have become more popular. Many first-time investors are attracted to these products and platforms for their low cost and simplicity.

However, these investors may be unaware that they do not have a say in the companies they invest in via these vehicles, nor do they have the same rights as direct shareholders. For instance, they cannot attend the companies’ annual general meetings (AGMs) to vote on corporate resolutions or question the board of directors.

“These investors should be aware that they are not the legal owners of the underlying shares and thus, are not in a position to select or dispose of the underlying shares according to their risk appetite. They have outsourced their risk appetite to the fund managers,” says Devanesan Evanson, CEO of the Minority Shareholders Watch Group (MSWG). 

“Also, these investors are not in a position to undertake shareholder activism in their personal capacity. It is up to the fund managers to undertake such activism.”

Investors can influence a company’s behaviour by exercising their shareholder rights or undertaking shareholder activism. Minority shareholders, for instance, can vote on issues related to executive remuneration or the appointment of company directors at AGMs. Major shareholders, who are usually institutional investors, may choose to engage directly with the company’s management.

Shareholder activism is often undertaken for the purpose of ensuring good corporate governance practices as these impact the company’s performance. In recent years, investors have used activism to get companies to be more sustainable.

So, if those who invest in ETFs do not have a say at AGMs, how can they ensure that their investments are aligned with their values? Should they still care?

Yes, according to Devanesan. These investors can choose which ETF providers or asset management companies to use. In this context, these fund managers actually have an incentive to push for better corporate governance practices in the investee companies because passive index-tracking funds usually hold their investments for the long term. Also, the fund managers cannot select the underlying stocks. 

“As passive investing vehicles track indices such as the FBM KLCI, they do not have a choice as to which stocks make up the index. Thus, they are not in a position to select counters that meet their corporate governance preferences such as climate change and gender diversity, which active fund managers can do,” says Devanesan.

“But while they do not have the option of not investing in certain stocks on those indices, they can bring about change through persuasion and influence if they articulate their thoughts on the companies in their portfolios at the AGMs and in private engagements with management.”

ETF investors can also put their money in passive funds that engage in shareholder activism to address issues related to their values.

Already, the pressure to act is heavy on the three biggest index fund providers in the US. BlackRock Inc, The Vanguard Group and State Street Global Advisors hold an average stake of more than 20% of the companies in the S&P 500, representing an average of about 25% of all shares that are voted in corporate elections, according to a study cited by the late Vanguard founder John C Bogle in a 2018 op-ed. In the US, the assets managed by passive index funds surpassed those of active funds for the first time last August.

A cursory look at the websites of two robo-advisors in Malaysia finds that the majority of the ETFs in their portfolios are provided by the three companies mentioned above. Currently, investors are not given the option to select their own ETF providers.

In recent years, BlackRock has said it will engage with its investee companies on issues such as climate change and corporate governance. Vanguard has issued similar statements.

“Even if passive funds do not have a choice when it comes to selecting the companies in their portfolios, they do have a choice as to whether they want to promote corporate governance through the powers bestowed on them as shareholders of the constituent stocks. The only difference between active and passive funds in this context is that the former can punish the delinquent companies by selling the shares as a form of market discipline,” says Devanesan. 



Fractional investing — the next trend

Robo-advisors are part of an emerging wave of solution providers that allow fractional investing in shares or exchange-traded funds (ETFs) at a low cost. The objective of these providers is to lower the barrier to investing.

At least four companies in the US — including Fidelity Investments, Robinhood Markets and Acorns — have launched fractional share trading (sometimes called micro-investing or dollar-based investing) since last year. 

These platforms attract young and digitally-savvy first-time investors who may not be able to afford the price of a full share. Instead, they buy a fraction of a share for as low as US$1 or with the spare change from their purchases made using their linked account or debit or credit card, via these platforms.. 

While these platforms are not available in Malaysia yet, the concept of fractional investing has already been introduced in the market. By not imposing a minimum investment amount, robo-advisors allow local investors to have fractional ownership of ETFs.

Investors who own only a fraction of a share may not have the right to a full vote on resolutions at annual general meetings (AGMs). According to the websites of several US-based fractional investing platforms, these service providers aggregate the votes of fractional investors and report the total votes based on the number of full shares.

Many investors on these US-based platforms are largely unfamiliar with their rights as shareholders. That is why solution providers such as shareholder engagement platform Say was launched there. In a previous interview with Personal Wealth, Jeff Cruttenden, founder of US-based micro-investing platform Acorns, said he saw the need to introduce Say when he realised many Acorns users were first-time investors, who were unfamiliar with their rights and overlooked important investor documents.

On Say, shareholders can direct questions and provide feedback to the listed companies as well as vote on resolutions. Prior to AGMs and other events, the companies can crowdsource questions from shareholders via the app. Third-party brokers and investing services can also use Say to send proxy materials to investors.

Such a product can address a pain point in Malaysia as it can provide a digital platform for shareholders to have conversations with the boards of directors, says Devanesan Evanson, CEO of the Minority Shareholders Watch Group.

“Currently, a shareholder must attend the AGM personally, or through a proxy, to raise any questions. The opportunity to raise questions throughout the year is still at a nascent stage. This needs to be developed to encourage greater shareholder activism. Such a platform should be efficient and effective and at a reasonable cost.”

To be effective, such a product must be managed by an independent party that will ensure irrelevant and unreasonable questions are weeded out beforehand.

“Currently, shareholders may pose questions to the board [outside the AGMs], but these may not see the light of day. In this case, the solution provider will have to track all the reasonable and relevant questions and call out companies that do not answer or fudge their answers to these questions,” says Devanesan.