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ANALYSIS: Is passive beating active at its own corporate governance game?

Corporate governance – where an investor aims to steward investee companies towards better long-term returns – has duly become one of the active fund industry’s key answers to the question of what value it adds.

Today, it is seen as so important for asset managers to demonstrate stewardship on behalf of their clients that an entire industry has sprung up around investor governance.

Investment Association research in 2014 claimed that more than 2,000 UK asset management staff were involved with governance, and that the number was rising.

But while active funds have an understandable interest in shepherding the shares they own towards better returns than those they don’t, the rise of passive funds as a proportion of the overall market may present a problem.

Passive funds are obliged to own every share on an index. Since they are neither trying to outperform – they merely want to track the market – nor authorised to sell out of a stock, they have no clear incentive to carry out corporate governance.

Moreover, their focus on keeping fees down may leave little room in the budget for governance, which may be seen simply as a frivolous expense by their accounting teams.

This may be one reason why Pimco, one of the world’s largest active managers, recently issued an attack on passive funds – accusing them of “free riding” on the back of work done by active managers.

Saker Nusseibeh, chief executive of stewardship-focused asset manager Hermes, has gone as far as to suggest passive funds act as “absentee landlords” and should be forced by law to engage in corporate governance, to prevent the rise of “ownerless corporations”.

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