Mutual Funds and Proxy Voting: A Rough Road Ahead?
The challenges of proxy voting
As pressure mounts on mutual fund companies to improve their oversight of companies they invest in, several fund managers are taking notice if not taking action. The mutual fund industry, which controls about 27% of the market capitalization of all US companies has been largely complacent with regard to holding companies accountable. But will this change?
While there are some exceptions, many mutual fund companies have historically failed to disclose their proxy voting records to mutual fund investors. In 2003, the SEC altered the rules with regard to proxy voting disclosure. Now mutual funds are required to disclose both their policies and their voting records. This transparency is the first step but not the last one.
Many fund voting policies grant managers wide discretion in how they vote on specific corporate governance issues. This “case-by-case” approach allows fund voters wide discretion in voting and undoubtedly allows them to assess every situation on its merits rather than holding to what some might consider a doctrinaire approach to proxy voting.
However, the flip side to this argument is that it leaves mutual fund owners largely in the dark on why their mutual funds vote one way or another at particular companies. Why does a mutual fund vote for separating the chairman and CEO positions at one company but not at another? So far, mutual funds have not been called to task on this question.
The good news for mutual fund investors seeking to maximize their investment returns is that mutual fund managers are feeling increased pressure since the 2003 voting disclosure rule went into effect. Stephen Davis of Yale’s Millstein Center for Corporate Governance says that “a sea change” could prompt funds to reach new standards of accountability. Financial Times (March 1, 2010),
Let’s hope so.
Mr. Davis goes on to note that at the very least, fund managers are looking at proxy voting not so much as a compliance exercise and more as a “decision linked to value.”
ProxyDemocracy, a mutual fund analyst, tracks a number of the larger fund companies proxy voting records. Overall, the industry’s record for holding companies accountable is a mixed bag. Still, as voting disclosure by mutual funds continues, it is likely that their records, like the companies they invest in, will be subject to greater scrutiny by investors.
6 Reasons to Vote Against Your Mutual Fund
As the editor of ProxyAnalyst, I am a big advocate for proxy voting. I proselytize on the subject and often bore my friends to tears when I wax on about it. However, even I – The ProxyAnalyst – shudder when I think about voting mutual fund proxies. Today, I propose to change that thinking.
For those of you brave souls who have even glanced at a mutual fund proxy, your fears are justified. If you are lucky, there is an item on the ballot for electing the fund’s directors. Not so bad even if you haven’t a clue who these guys are. Unfortunately, things are not so simple.
More often than not, the only item on a mutual fund ballot is some variation on a sub-advisor agreement or perhaps an investment management services agreement. While these types of proposals can have a direct bearing on the cost of owning a mutual fund, the language and supporting statement of these proposals are steeped in legal prose guaranteed to induce a coma.
This is the moment when the proxy meets the trashcan.
But wait. There is an alternative.
I happened upon an interesting post on BetterInvesting.org’s website entitled “Six Questions for Your Fund Company.” While it’s focus was on evaluating the performance of readers’ mutual funds, it has some value when evaluating the performance of the funds when it’s time to vote. Here are the six factors, slightly modified, that can help mutual fund owners vote their proxies:
1. Have the fund family’s expense ratios fallen in the last five years?
If expense ratios have actually fallen over the past five years then good for you. However, this is unlikely. In fact, just the opposite is more likely to occur. Has the fund’s performance plummeted while its fees rise? This is probably the more likely scenario that most mutual fund investors are experiencing today.
Sure, managers can blame market conditions for the decline of the fund. But shouldn’t the managers share in some of the downside risk just like its investors? If you find that your fees are rising while the value of your fund is declining, consider voting against any and all proposals put forth by management on the proxy. Harsh? Yes, but it’s a wake up call you are after here.
2. How many new funds has the family launched in the last five years?
This is an interesting issue that Better Investing raises about fund families. Is the fund flittering around looking for the next big idea rather than buckling down and focusing on what it said it would do with its existing funds? Combined with poor fund performance, fund drift reflects poorly on the management of your assets. A vote against the fund’s directors is an appropriate response in such cases.
3. Do managers comment on their successes and failures in fund company literature?
Being honest and open about your failures as well as your successes is a seemingly rare commodity on Wall Street. To the fund managers who are capable of accepting responsibility for their failures rather than blaming the market, “Huzzah!” But for those managers who blame the market or other external factors when their fund performance trails its peers, it’s time for you, Dear Investor, to cut off their allowances and send them packing. My suggestion? Vote against all management agreement changes (these probably include fee hikes) and vote against all non-independent directors.
4. Does the fund family appoint and support independent directors on fund boards?
As I have noted elsewhere at ProxyAnalyst, board independence is a critical issue. Independent directors help create balance on a board so that the fund’s shareholders get some consideration instead of just the fund’s managers. At the very least, there should be a majority of independent directors on the fund’s board, preferably 2/3 of the board should be independent. If not, vote against all non-independent or inside directors.
5. On average, how long do managers remain at the helm of the family’s funds?
To put it another way, is there relatively high turnover at the helm of the fund? This might suggest management problems at the fund family level. It also might suggest that the fund board is not paying attention to what is going on. Combined with other factors such as poor fund performance, fund drift and so on, a no confidence vote against all of the directors might be in order.
6. Does the fund family disclose its proxy voting record?
Last but not least my favorite, the fund’s own voting record. Today, mutual funds are obligated to disclose their proxy voting records. The SEC’s NP-X rule requires this disclosure. But as with many rules, the devil is in the details. Take a look at the web site for your mutual fund. Is the proxy voting record easy to find? What about the fund’s voting policies? Perhaps the most troubling thing about fund voting policies I have observed is the general vagueness of voting policies. I have found that many voting policies give managers significant discretion in voting any way they choose. This means that fund managers can let their portfolio companies get away with gross bonus payouts, poor corporate governance practices and other actions that are not in the interest of investors. A quick reference tool for understanding how many mutual funds vote, visit ProxyDemocracy.org, where you can analyze voting trends at many of the major mutual fund families.
Director Accountability: The 5 Worst Mutual Funds
As I noted earlier this week, I have dusted off my copy of a study done by the Corporate Library, AFSCME and the Shareowner Education Network called Compensation Accomplices: Mutual Funds and the Overpaid American CEO. Filled with charts and tables, the study makes a couple of interesting findings. One that caught my attention as I reread the report was a table on page 20.
In 2007, the study found that certain mutual fund companies voted to support directors standing for election or reelection more than an astounding 90% of the time. This compares with the average rate of voting for directors by the mutual funds studies of 58%. What this means in real terms is this: Regardless of how well or how poorly companies performed, regardless of how directors performed in overseeing companies on behalf of shareholders, the worst offending mutual fund companies voted to reelect them.
So who are these mutual funds?
Here’s the list of the funds and their percentage votes in favor of directors:
- Fidelity - 92%
- Columbia – 97%
- Federated – 97%
- American Funds – 100%
- Scudder – 100%
Until mutual funds begin to take responsibility for their investments and demand that companies take the issue of director accountability, excessive compensation and related governance issues seriously, examples such as this will likely continue. But what can an ordinary investor do?
Simple. Vote down all proposals on their mutual fund proxies. A bit of overkill? Perhaps but it raises the discussion level on this serious problem. Clearly mutual funds don’t hear what individual shareholders are saying right now on this issue.