Vanguard letter to chairmen promotes better governance

Several hundred company chairmen received a letter last month from Vanguard, the fund company, outlining proposals to strengthen the relationship between board directors and long-term shareholders.

The letter sent by Bill McNabb, Vanguard's chief executive, is part of a drive to improve corporate governance standards. With more than $3tn in assets, Vanguard is now the world's second-largest asset manager and a permanent shareholder in every major public company worldwide.

The US fund house has historically conducted a policy of "quiet diplomacy" when engaging with companies, which has led some critics to question whether this approach represents the best use of its voting power.

Vanguard admits some companies have, in the past, "mistakenly assumed" its predominantly passive investment management style suggests a passive attitude towards corporate governance.

But that is something Mr McNabb rejects.

"Nothing could be further from the truth," he says, adding that good governance is central to helping companies maximise returns to shareholders.

Jane Goodland, co-head of sustainable investment at Towers Watson, the consultancy, believes the largest managers of institutional investment money, such as BlackRock, Vanguard and Legal and General Investment Management, "play a critical role in setting the tone for governance standards".

Ms Goodland says large passive managers arguably carry a greater burden of responsibility as corporate stewards as they cannot walk away from their investments, unlike active managers who are free to sell their holdings.

Critics say there is more talk than action.

Catherine Howarth, chief executive of ShareAction, the investor rights charity, says there is a risk that asset managers are becoming more skilled at marketing their stewardship activities than improving the quality of stewardship itself.

Not all fund managers take these issues seriously, she believes, even though investors increasingly recognise the importance of active stewardship in delivering long-term value.

"There can be a disconnect between a fund manager's business model that is commercially incentivised to maximise assets and the manager's responsibilities as a good steward in looking after the best interests of their clients," says Ms Howarth.

But she does acknowledge there is "genuine progress under way" on stewardship in the asset management sector.

An important plank of Vanguard's plans is the creation of "shareholder liaison committees" that will gather "unfiltered perspectives" on strategic issues and environmental, social or governance considerations. The committees will also tackle potentially difficult issues such as executive pay.

The case for effective engagement is compelling for both shareholders and boards, says Mr McNabb, but "too often" there is precious little communication between the two parties.

Professor John Kay, author of the 2012 Kay Review, which criticised the lack of engagement by asset managers with investee companies, welcomes Vanguard's letter, calling it "a move in the right direction".

Other initiatives are under way. Last month, the $175bn Canada Pension Plan Investment Board and McKinsey, the consultancy, launched a joint initiative to encourage companies to identify long-term shareholders and foster dialogue with them about their strategic goals.

CPPIB and McKinsey also called for the development of long-term performance metrics to assess management and for more engagement with shareholders. The initiative was backed by BlackRock, Singapore's sovereign wealth fund GIC and Axa, the French insurer.

Alan Palmiter, professor of business law at Wake Forest University in North Carolina, believes Vanguard's letter is evidence of a shift in the relationship between asset managers and companies. He says it is notable that Vanguard does not just want better access for itself, but also for other institutional shareholders that may have different perspectives on ESG issues.

"Vanguard may well be changing the nature of engagement between company managers and institutional shareholders, to the benefit of all," he says.

Ms Goodland adds: "The penny has dropped that this is an area where collaboration will be much more productive than competition."

Last month the UK Sustainable Investment and Finance Association hosted a conference to discuss how better reporting of ESG data and stewardship activities could lead to a greater understanding of how these factors contribute to long-term returns.

The conference marked the launch of "red lines voting", a move to encourage pension scheme trustees to vote on governance and ESG issues, rather than just leaving those decisions to delegated fund managers.

"Failures in governance have led to deaths and injuries, reputational damage and huge fines as well as declines in asset values," Janice Turner, co-chair of the Association of Member Nominated Trustees, which represents pension funds managing £350bn, said at the conference.

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