How voting in pooled funds works today: the facts and flaws.
An introduction to pooled funds
Fund managers manage funds, some of which are “pooled” or “commingled”. Pooled funds are when the capital from all investors sits in a single account and is invested as one. All investors in the fund subscribe to the same prospectus, which outlines key details such as the investment strategy (usually focused on capital allocation). This structure enables the fund manager to gain economies of scale – which they pass on to their investors in the form of reduced fees.
Fund managers charge fees to investors as a percentage of the assets under management (AUM). At the highest level, there are two types of fund managers: passive and active.
- Passive managers buy shares according to an index. An index is simply a set of companies that follow a particular rule set, e.g., the S&P 500 index lists the 500 largest publicly traded companies in the US that have been profitable for the last four quarters. Passive funds give the investor exposure to a particular set of companies for as low a fee as possible.
- Active managers pick shares. Their goal is to beat a particular index, delivering “alpha” to the investor (alpha is the percentage by which they outperform their chosen index). Using the capital within the pooled fund, both types of fund manager purchase shares to deliver on their strategy. Due to the pooled fund structure, when these shares are purchased, they are done so in the name of the fund managed by the fund manager. They are the “registered shareholder”. And as such, they receive the accompanying shareholder rights.
So, what’s the problem?
Currently, the “Big Three” fund managers (BlackRock, Vanguard and State Street) cast about 23.5% of the votes at companies listed on the S&P 500. Experts also predict that the Big Three’s influence will rise to 40.8% by the mid-2030s if current trends continue, making them the most powerful actors in the corporate governance world. Even today, ShareAction’s 2022 Voting Matters Survey found that 49 additional resolutions would have received majority support if BlackRock, Vanguard, and State Street Global Advisors had voted in favour of them.
This influence isn’t limited to the prominent players within the fund-management space. As assets with any fund manager grows, so does their influence. However, these fund managers often have different longterm incentives than those of the people or institutions whose money they manage. Whilst fund managers can vote in different directions on the same proposals across different funds, they are limited to voting shares in a single direction in a pooled fund.
This begs the question: How could voting facilitate better alignment between ultimate asset owners and investment managers?
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