Much has been said about active and passive management in the past few years. That debate has almost solely focused on relative performance and the factors driving it. One important aspect of this debate that does not come up so often is shareholder engagement. That is a big hole in the debate, because engagement is one of the areas where active management can add value and drive long-term outperformance for investors.
Engagement matters. And because genuine engagement requires informed judgement, experience in making such judgements is vital.
Passive investors argue that, because they cannot sell, they are long-term investors. They often point out that active managers who do not like the direction a company is going in can simply sell the stock.
While that may be true with some investors, it is not true for many others. At Neuberger Berman, we invest in a company because we recognise the quality and added value of the products or services it has developed, and want our clients and other shareholders to benefit from them.
We always intend to hold a company, from day one – and that entails a continual evaluation of that company. We do not start scrutinising things only when we become aware that something might be amiss, and if we do see a management team wavering from delivering long-term value, we engage with them. Selling is potentially leaving unrealised value on the table, and we do not like to do that.
In addition, we think passive investors are along for the ride. The big passive investment managers lack the experienced resources to engage genuinely with a company or make judgements about the quality and success of its management team. They employ relatively small teams of people in ‘stewardship’ roles, most often focused on the proxy-voting process. While necessary, that event generally only happens once a year and is often focused on relatively immaterial issues that are nowhere near what is required to truly understand how effectively a company is governed.
Compare that small number of proxy-voting roles with the hundreds of portfolio managers and research analysts, many with decades of experience in analysing companies and industries, that a firm like Neuberger Berman deploys.
Do not get me wrong. We also focus on the proxy process, particularly the election of board members, but that on its own it is not enough.
Who will hold company management teams accountable if not for active managers?
Passive investors, given the flows of the past few years, now hold quite substantial positions in most public companies, often in the 15 per cent to 20 per cent range. Combine that with quantitative equity strategies, which also show little interest in direct company engagement, and you can see the problem.
For example, is there a more important topic for shareholders than the decision making around a company’s capital allocation process? That almost never shows up in a proxy statement. What about the makeup of the board? While this does show up in the proxy, who is assessing the experience and expertise of the individuals who most directly represent shareholders’ interests?
What about other issues such as a company’s environmental or social responsibilities? Recently, for example, we have seen a debate over investor ownership of the listed gun manufacturers: Olin Corp; American Outdoor Brands; Sturm, Ruger & Co; and Vista Outdoor. Neuberger Berman’s mutual funds do not hold any long positions in these gun manufacturers. Passive investors do own shares in those companies – they have to. But they have only recently started ‘engaging’ with them – which usually means sending questionnaires. I guess that is the passive investor’s version of ‘engagement.’
Assessing whether a company is well governed – and holding management accountable when it is not – requires judgement, not box-checking. We think good active managers harness decades of experience and sector expertise and are among the few financial market participants that are genuinely informed about those aspects of a company.
Any investor hoping their fund manager will hold a company management team to account on both shareholder value and environmental and social sustainability would do well to remember that you get what you pay for.
Joseph Amato is chief Investment Officer for Equities at Neuberger Berman.
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