MASSIMO MASSA: Research shows major mutual funds vote for political influence

One of the realities of today’s financial markets is the outsize shareholder voting power held by the leading mutual funds. In 2021 the top three asset management companies (BlackRock, State Street and Vanguard) owned about 23% of the S&P 500 firms. This made them the largest shareholders in 88% of the leading US companies.

Worryingly, it seems they are quite happy to use that shareholder voting power to please politicians and regulators, rather than to police underperforming companies. They are willing to play a political game and actively shift voting preferences to match the prevailing political mood in Washington.

This conclusion was based on my research, conducted with Lei Zhang of City University of Hong Kong. We focused on the voting behaviour of the US mutual funds over the 17-year period between 2004 and 2021. In particular, we looked at how fund managers voted on sensitive (and potentially political) shareholder proposals relating to environmental and social issues and how this behaviour altered depending on what political party was in charge.

Overall support for environmental and social proposals was low, with less than 30% of leading funds voting in their favour during this period. However, what our study found was that how fund managers voted actually shifted at specific times to reflect the shifting balance of political power.

This was regardless of voting recommendations of proxy advisers such as Institutional Shareholder Services (ISS), which typically suggest voting in a certain way based on the best financial outcome for shareholders. It was also regardless of the individual fund manager’s personal political beliefs. Instead, they voted to gain the fund family the most political capital.

During periods when the Democrats were in power, asset managers from the leading mutual funds were actually 30% more likely to vote in favour of stronger environmental and social proposals. Yet this figure slipped to just 23% when there was a split majority in Congress and plummeted to 17% when the Republicans were in power.

Demonstrating that these actions were politically motivated is the fact that this behaviour was not observed when we analysed voting patterns for shareholder proposals not related to environmental and social issues.

Keeping close

Even in today’s online world, physical proximity clearly offers the chance for greater access and potential influence. And indeed, location was also a factor in how fund managers voted. Those firms based closest to the corridors of power in Washington were even more likely to vote in line with the party in charge. The access offered by the physical closeness to the political movers and shakers allowed these funds to be even more attuned to the political preferences at any given time.

Political flexibility in voting behaviour was mostly concentrated among the top 10 biggest mutual fund groups. In fact, they were more likely to vote in line with the political majority than other smaller funds. This suggests their size and clout gave them greater power to lobby politicians, further increasing their ability to align to the current political mood.

Scrutiny

Perhaps equally important, these larger funds also face far greater scrutiny from legislators due to their sheer size and influence. After all, BlackRock alone accounts for about $10-trillion in managed assets, which is more than is traded on the New York Stock Exchange. It is little wonder that US financial regulators such as the Securities & Exchange Commission and the Federal Trade Commission keep a close eye on their activities, including how their fund managers vote.

These funds are already heavily regulated, though in many cases regulations are tightened or relaxed at the discretion of these regulatory bodies, whose commissioners are appointed by the president with the advice and consent of the US Senate. Their focus and attitude towards regulating the asset funds market is therefore influenced by the party in charge.

At the same time, the US Congress is responsible for introducing numerous bills directly related to the finance sector. It clearly does mutual funds no harm to be seen to be actively supporting the political ideology of the people in power. To do the opposite runs the risk of prompting greater scrutiny and stricter regulations.

A desire to cater to the political power most likely to craft regulation was underlined by the general disregard for US state politics. The party affiliation of the state governors of the underlying portfolio firms’ headquarters did not affect voting behaviour. Political catering is undertaken to curry favour with the legislators in Washington.

Need for disclosure

The challenge is how to deal with this behaviour, which we define as “stewardship theatre”. Given the increase in political polarisation, our findings have important policy implications for future regulation. Unlike the more transparent political influencing that comes from giving direct financial donations to the individual parties, this behaviour is more subtle.

Fundamentally, it’s a question of how to regulate lobbying or political pressure. Clearer disclosure of such behaviour would be one solution, but it’s perhaps naive to believe it’s something that mutual funds would undertake willingly.

The upcoming US election offers the very real possibility of a change of political party in the White House. It seems likely it may also lead to quite different voting behaviour among the top US mutual funds as they look to shift allegiance and maintain their political influence.

• Massa is professor of finance and the Rothschild chaired professor of banking at INSEAD.