Why Passive Management May Be Bad For You

Financial and business graphs, Finance concept

Financial and business graphs, Finance concept

Active managers actively decide what to include in their clients’ portfolios. Passive managers track market indices instead of choosing individual stocks.

The merits of active management have come into question following the recent trend towards passive management. Typically the two methods are compared during portfolio construction and cost analysis. There is however, an often-overlooked aspect of active management that is of vital importance, namely, shareholder activism. Shareholder activism includes voting at shareholder meetings and engaging with company management.

Engaging With Companies

Some investment management companies believe that better investment performance can be achieved through engagement with board members and executives whose securities they have purchased for clients. Engagements like these could shape a company into a financial prospect that is more sustainable long-term and potentially improve the company’s valuation.  On the other hand, passive managers rarely engage with companies they have invested in.

Engagements typically include meetings with non-executives and executives, written correspondence, site visits, analyst days, conferences and road shows.

These engagements address various issues affecting a company’s long-term economic success. Neglecting social and governance (ESG), environmental and sustainability issues may negatively affect company earnings and decrease its valuation.

Some companies will provide voting recommendations for general meetings when a client owns a significant portion of a small company, or when a company has a material weight in the client’s portfolio. Some companies disclose these recommendations and the result of the shareholders vote on a relevant resolution can on their website.

Responsible Investment Requires Active Management

Initiatives, such as the local Code for Responsible Investing in South Africa (CRISA) or the global UN supported Principles of Responsible Investment (PRI), help to increase the attention that responsible investing is getting. This is beneficial to investment managers since well-functioning, stable and well-governed environmental, social and economic systems influence the sustainability of long-term returns. The effectiveness of responsible investing relies on active investment research. This means identifying issues and intelligently engaging management. It also relies on active investment management. This allows managers to exclude companies, which don’t deal with or respond to their ESG challenges. Passive investment managers are poorly equipped to deal with these issues and therefore rarely address them. This weakens the shareholder’s ability to drive ESG issues through engagement, thus affecting their long-term return.

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