Singapore-based financial blog that aims to educate people on personal finance, investments, retirement and their Central Provident Fund (CPF) matters.

Sunday, 15 March 2015

How ETFs are changing the world of activists (Inspired by an article in Economist)

This post is inspired by an article that was in the Economist, edition dated 7 - 13 February. You may read the following article here:

While this is just a sub-topic of the entire article, I believe this would likely be the future of our market if more investors turn towards passive investing via ETFs.

ETF investing may prove to be most rewarding to an investor where it requires the least effort but able to  replicate the market returns, which averages beat the average inflation rate. However, when you are investing into ETFs, the index fund uses your money to invest into the underlying basket of stocks. This means that while you have the ownership of the underlying companies' shares via the index fund, you are indirectly transferring the rights of these ownership to the index fund. This can known as the proxy voting which shareholders would receive every year to transfer their votes to another shareholder by filling up a proxy form. This may save the investor the trouble of managing multiple corporate-related actions, it can also have other implications.

Firstly, the index fund now has the power to change the board directors and influence other major corporate decisions. If the index fund is extremely large, this also means that the fund has huge voting powers that can predominantly change the company. While most passive funds often take a less active role, we can see that they are increasingly being more involved as they realised their responsibilities. As stated in the article, this is still mostly handled by proxy advisory firms, which may be ousted once large funds such as BlackRock and Vanguard start to handle themselves.

You might be thinking what could be the impact of the transfer of voting rights. For one, the index fund might unknowingly change the culture and values of the company if they handle without care. Index funds are usually one of the public shareholders and with their passive approach towards handling corporate decisions, they may be influence by activists via the proxy advisory firms. As such, board members could be changed, undermining the existing culture of the company and implement new disruptions to the companies' existing activities.

With the American market facing this issue, it is highly probable that our market will move towards it, given the popularity of ETFs among retailers.

Feel free to discuss any other topics below that you find interesting in the article as it is predominantly written on activist funds.

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