1. Chapter 9 Mutual Funds as Institutional Investors

2. The Importance of Institutional Investors The largest owners of stock in the United States are now institutional investors who manage money for others. Institutional Ownership of the Top 1,000 Corporations Source: The Conference Board, 2009 Institutional Investment Report

3. The Importance of Mutual Funds Mutual funds are the largest holders of stock among institutional investors. U.S. Holdings of Stocks by Institutional Investor Type Source: SIFMA, Fact Book 2009

4. Corporate Governance Stockholders are the owners of a company. –They elect a board of directors to represent their interests. The board appoints a CEO to manage day-to-day operations. –The board oversees the work of the management team and guide the company on strategic initiatives. Stockholders also vote on other significant matters. The specifics of corporate governance are determined by: –State law. –Stock exchange rules. –Federal regulations. –The company’s charter and by-laws.

5. Indirect Stockholder Control

6. Stockholder Meetings Most companies are required to hold a stockholder meeting at least once a year. –At these meetings, stockholders elect a board of directors and vote on other proposals. Companies send detailed information about the proposals to shareholders before the meeting in a proxy statement. –Most proposals are submitted by management, though some may be submitted by stockholders. Few stockholders physically attend the meeting; most cast their votes in advance. –This process is call proxy voting.

7. Proxy Voting by Mutual Funds Mutual funds must publicly disclose: –Their proxy voting policies and procedures. –The proxy votes cast throughout the year. –How they manage conflicts of interest with regard to voting proxies. Mutual fund proxy voting policies: –Generally begin with a statement of principle, which is often to vote in the best, long-term economic interest of fund investors. –Outline how the fund will vote on the most common proposals. Director elections and executive compensation are usually covered. –State that votes on other proposals will be determined on a case- by-case basis. They may explain the general principles that will be used to evaluate these proposals.

8. Proxy Voting Decisions Institutional investors may consult the following when making proxy voting decisions: Academic research. Proxy advisory firms. –The leading firms are RiskMetrics and Glass Lewis. Engagement = information provided by companies. Fund boards of directors. –Boards approve proxy voting policies and review votes at least annually. –Some boards may determine votes on specific issues.

9. Stockholder Activism Activist investors seek to earn a return by advocating change at a company. They may: –Nominate an alternative slate of directors. –Express dissatisfaction with management in the media. –Submit shareholder proposals. –Lobby against management’s recommendations. Some state and union pension funds have become prominent activists. –Many of these funds have a substantial proportion of their assets invested in stock index funds.

10. The Wall Street Walk Some investment managers argue that it is simpler and more effective to simply sell a stock rather than try to influence management. –This is sometimes referred to as the Wall Street walk. –Active managers (as opposed to index fund managers) usually take this route.

11. Anti-Takeover Provisions Stockholder activism took hold in the 1980s in reaction to increased use of anti-takeover provisions. These include: –Stockholder rights plans. –Staggered (or classified) boards. –Supermajority voting. –Control share statutes. –Stakeholder constituency statutes.

12. Current Issues in Proxy Voting At most companies, shareholders can vote for directors or withhold votes – but they can’t vote against a director. Many companies have adopted procedures requiring directors to resign if they don’t get a majority of votes. Plurality voting In 2010, the SEC adopted new rules making it much easier for shareholders to nominate director candidates. Proxy access Companies are now required to ask stockholders their opinion on executive compensation at least once every 3 years, through a vote called “Say on Pay”. Executive compensation

13. Mutual Funds and Social Change Socially responsible investing funds seek societal change as well as a financial return. They: –Invest only in companies that meet specific criteria. –May actively seek out companies that have adopted certain practices. –Often engage in stockholder activism. Responsible investing includes environmental, social, and governance (ESG) considerations into the investment analysis. –Some fund managers have signed the UN Principles for Responsible Investing.

14. The UN Principles for Responsible Investment Signatories to the UN Principles for Responsible Investment agree to: 1.Incorporate ESG issues into investment analysis and decision-making. 2.Be active owners. 3.Seek appropriate disclosure on ESG issues. 4.Promote acceptance and implementation of the UN PRI within the investment industry. 5.Work with other signatories to enhance the effectiveness of the UN PRI. 6.Report on activities and progress toward implementing the UN PRI.

15. Proxy Voting Outside the U.S. Owners of non-U.S. stocks may face challenges in exercising their rights as stockholders. –There may be a dominant stockholder, which may be the government. –Rights of minority stockholders may be limited, and directors may not be required to represent their interests. –Voting proxies may be difficult because information is not available or because of operational challenges.