Much has been said about active and passive management in the past few years — and we have weighed in on that issue. That debate has almost solely focused on relative performance and the factors driving it. One important aspect of this debate that doesn’t come up so often is shareholder engagement. In my mind, that’s a big hole in the debate, because we believe that engagement is one of the core value-added propositions of active management and is critical in driving long-term value for investors.
Engagement matters. And because genuine engagement requires informed judgement, experience in making judgements about companies is vital.
Depth and quality
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, our portfolio managers invest in a company because they recognise the quality and value-add of the products or services it has developed, and they want our clients and other shareholders to benefit from them. Unlike a passive investor who has to hold a company, for us there was always the intention to hold a company, from day one — and that entails an ongoing history of continual evaluation of that company. In other words, experience matters, but so does the experience of working with specific companies over a long period of time. We don’t 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. In our view, selling is potentially leaving unrealised value on the table, and our portfolio managers don’t like to do that.
Moreover, in reality, 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.
Don’t get me wrong. We focus on the proxy process, particularly the election of board members. My point is, while necessary, that’s not enough.
Holding boards and management accountable
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—20% 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 make-up 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 does 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’s 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 that bottom-up fundamental 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.
When it comes to holding company management accountable, on both shareholder value and environmental and social sustainability, engagement and judgement matter — and we believe you get what you pay for.
— Joseph V. Amato, President and Chief Investment Officer — Equities Neuberger Berman