Why fund managers need to become more active

Some clever American academics have done intensive research and come to the conclusion that not all shares are equal; some are more equal than others. It depends on who’s holding them.

For this, we should be very glad.

In a paper titled “All Shareholder Votes Are Not Created Equal”, academics Davidson Heath, Da Huang and Chong Shu state: “We find that the identity of the shareholder matters as much as, if not more than, the number of shares they hold: firms are twice as responsive to the votes of active funds as those of passive funds.”

The research focuses on voting for directors at AGMs because director elections are among the most important mechanisms through which shareholders have an impact on corporate governance. 

The authors reckon that even if a director secures the necessary votes to stay on the board, the fact that certain active investors have voted against the director is likely to adversely affect his tenure on the board.

It’s tempting to say that this is as it should be, that investors who put in the effort should have more impact. But it should be that all investors put in the effort. Sadly, it seems, the majority don’t.

“Passive funds do less research and monitor the firms less,” say the academics. Because of this, the signal conveyed by their votes is less valuable. Management realises this and so is less inclined to respond.

Another major reason management is less likely to respond to passive investors is that, in the US, passive funds are required to hold a representative sample of an index. This means they cannot sell their shares even if they disagree with management. They are captive. 

By contrast, active funds can exit. This is a useful threat against underperforming managers.

So, all in all, there’s good reason for management to be more responsive to active shareholders.

Active managers dominate, but …

The South African market does not fit easily into the active-passive fund dichotomy. For starters, passive funds make up only about 9% of the R3.6-trillion in assets under management in this market. 

However, the bulk of the remaining 91% of assets under management are not managed actively in the way that US active funds operate. Indeed, because of a few key characteristics of the local market, the management style of much of this 91% could be described as close to passive in management style, if not in fees. 

First, the comparatively small size of the local market means the ability to exit individual investments is limited. 

But more significantly, as Chris Logan, CEO of Cape Town-based Opportune Investments, suggests, a crucial determinant of local fund management behaviour is that the primary goal of these institutions is to increase assets under management. 

“That means you have to offend as few people as possible,” says Logan, who, as a truly active investor, has “offended” many entrenched corporate management teams over the years. Pick n Pay, Trencor, Tongaat and Nampak are just a few of the names that come to mind.

Logan has been involved in high-profile battles with each of these companies. At Pick n Pay, he fought for years for the removal of the pyramid structure that secured the control of the Ackerman family long after that control was productive. Similarly, at Trencor, he fought to remove a value-destroying management structure. 

At Tongaat, Logan was warning about troubling asset valuations long before this very issue brought the sugar company to liquidation. Over at Nampak, Logan assailed the board at several AGMs about the value-destroying capital allocation decisions that brought the company to the brink of liquidation.

Are active managers MIA?

You might wonder, where were the large institutional fund managers during all this time? Well, if you check out the voting results of the AGMs, you will find they were firmly ensconced on the side of the underperforming boards and their entrenched management teams.

Recall the grovelling apology issued by Investec after its top analyst queried the tenure of long-serving Tongaat CEO Peter Staude.

After Investec analyst Anthony Geard said, in a note to clients, “we think it’s time for the CEO [Staude] to step aside”, an Investec spokesperson promptly issued a statement noting that, “to the extent to which it has caused embarrassment to Mr Peter Staude, with whom we have had a long and fruitful relationship, we apologise”.

The expectations that institutional shareholders would always be compliant were also on display at Sasol ahead of its 2023 AGM (which was paused and then postponed to January 2024). Old Mutual’s Investment Managers’ head of sustainability publicly recommended that Sasol shareholders vote against a number of resolutions.

Sasol, one of the world’s worst polluters, was incensed and immediately launched a counteroffensive. 

That counteroffensive had limited success, as evidenced by the comparatively strong opposition to the targeted resolutions at the AGM. But what should we make of the fact that Old Mutual’s head of sustainability parted ways with the company amid the kerfuffle?

It’s impossible to exaggerate the threat posed by passive investors to the viability of shareholder capitalism and, more urgently, to the value of the investments of millions of savers and pensioners.

The deference expected of institutional fund managers means a key function in the supposed efficient working of this system is absent. If the shareholders – or the fund managers paid to act on their behalf – are not engaged, then the system risks feral disintegration. 

Without active shareholders, poorly performing entrenched management teams risk no repercussions; remarkably, they don’t even risk the loss of bonuses, given that generous remuneration schemes are now baked into executive life.

Roping in the activists

Logan tells Currency that the good news is that some real active investors are making solid inroads into the South African market. A2 Investment Partners and Value Capital Partners have done some amazing work rescuing former corporate stalwarts abandoned by passive investors. 

Altron, PPC, Sun International, Nampak and Novus Holdings are all on a much stronger footing thanks to the active involvement of their shareholders.

Additional good news, says Logan, is that large institutional shareholders are tending to rope in activists to achieve certain objectives. Obviously, this is done without fanfare.

This is part of an encouraging trend of greater acceptance of activists, says Albie Cilliers of Cilandia Capital, who single-handedly pioneered the use of appraisal rights to secure the interests of minority shareholders in South Africa. The introduction of appraisal rights in the 2008 Companies Act was a major boost for activism, Cilliers tells Currency.

During his decade of activism, Cilliers has taken on many of the most powerful players in the corporate community – fund managers, corporate law firms, corporate advisers and often regulators – and generally won. But they have all been hard-fought battles that have taken their toll. 

“Going up against big players when you have limited resources is daunting; you never fully know the extent of the risk,” Cilliers says.  You can’t afford not to know everything your larger opponent knows, plus some. 

Fortunately, with each success, life does get a little easier. Cilliers feels there’s less antagonism and more of a willingness to work with him. And making more shareholders equal can only be good news for the vibrancy of the system.