ETF voting rights: how do they influence companies?

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Company share ownership usually confers voting rights because shareholders are part owners of the business. But how do those rights work when you invest through an ETF?

ETF voting rights: how do they influence companies? In reality, you own shares in the ETF and the ETF owns the underlying securities, which means it’s the ETF provider that wields the voting power. But ETFs can build a significant block vote from the investing inflows of many small investors enabling them to actively influence companies despite their passive reputation.  

 

Voting rights protect shareholder value

Voting usually takes place at company general meetings. Rights vary but typically shareholders vote on decisions with immediate consequences for their interests such as dividend payouts, stock splits, mergers and acquisitions. Shareholders may also have the right to vote on executive pay.

Long-term shareholders, such as passive investors, have a special interest in shaping management decisions that can impact company performance over the long run. This includes voting on board structure and social responsibility issues such as the fair treatment of employees and environmental sustainability.

 

ETF voting power varies

Voting power varies relative to the size of a shareholder’s ownership, activism and the rights of shareholders as provided for in a company’s constitution and its country’s corporate law. ETF influence is also dependent on a few factors peculiar to the fund’s structure:

Synthetic ETF providers do not actually own the shares of the companies they track. Therefore they don’t vote on the companies that matter to their investors’ returns.

Physically replicating ETFs do usually own the shares of the companies they track and so enjoy voting rights. The exception occurs when an ETF uses an optimised methodology. In this case, the ETF doesn’t hold shares in every company in the index. Companies are dropped where they are too small to make a real difference, and/or trading is too costly. Naturally, no shares in a company means no votes.

An ETF provider’s voting power may also be diminished if it lends securities to lower costs. The rights follow the share, so an ETF can’t count on votes from shares out on loan.  

As rapid as the growth in European ETFs has been in recent years, they aren’t big enough to hold a majority stake in companies. The largest ETFs could tip the balance in some situations but as ETFs control less than 4% of global market capitalisation, cost-conscious managers must carefully weigh up whether exercising a small vote is worth the expense.

 

ETF provider voting policies

The handling of ETF voting rights is still developing in Europe but the growing demand for Socially Responsible Investing (SRI) shows that investors are interested in ethical investing strategies. Most ETF providers have published voting policies and they usually include an ESG (Environmental, Social, Governance) dimension.  

BlackRock, the owner of iShares ETFs, is the largest fund company in the world. It leverages that influence by pooling its votes in the hands of a dedicated team that engages with companies in line with BlackRock’s stated policies. Vanguard, the second largest fund company in the world and another US titan, works in a very similar way.

Medium-sized ETF providers often delegate their voting rights to proxy voting agencies (also known as proxy advisory firms). This saves the ETF’s management from the expense of expending resources to develop a voting position on every individual company in the index – a cost that would inevitably impact OCFs. Instead, the ETF provider issues guidelines to the proxy voting agency which is responsible for researching the issues, casting votes or advising the provider on voting decisions.

Deutsche Bank’s asset management arm DWS (Die Wertpapier Spezialisten) is an example of a provider that uses proxy voting agencies. DWS also clubs together the votes of its ETF and active funds to create a more influential block vote. Voting results are published on the DWS website.

UBS, by contrast, uses its own internal committee to manage the voting rights of ETFs and active funds. The results aren’t made public but can be requested in writing.

Ultimately, the absolute influence of ETFs is still relatively low but it’s growing as assets under management scale up. ETF providers are generally transparent about their voting policies and use their influence to positively engage with companies on sustainability issues.
 
Our tip: buy ETFs that track SRI indices if you want to increase the ethical impact of your investments.