Sunday, September 9, 2012

How Do Mutual Funds Navigate Proxy Voting?

Mutual funds hold substantial power to influence corporate governance around the world.  In the United States alone, mutual funds own over a quarter of the outstanding shares of U.S. stocks. Clearly, this represents an enormous amount of the voting power. And, along with all this power comes great responsibility. How can funds vote these proxies effectively, that is, in the best interests of the funds and their shareholders?  The Mutual Fund Directors Forum, an educational organization for mutual fund independent directors, has released practical guidance to address how fund trustees and directors can exercise oversight of their proxy voting processes.  

The paper, "Practical Guidance for Directors on Oversight of Proxy Voting," examines several questions that the Forum suggests fund boards should consider when reviewing their proxy voting processes.

  1. To What Extent Should Proxy Voting Duties Be Delegated?
  2. How Should Third Party Proxy Firms Be Utilized?
  3. To What Extent Should Investment Professionals Be Involved in the Voting Process?
  4. What Process Should Be Used for Overriding a Fund’s Voting Guidelines?
  5. Should Funds in the Same Complex Be Permitted to Split Votes?
  6. How and When Should Funds Engage with Portfolio Companies on Upcoming Votes?

The report not only discusses these key decision points directors often consider when establishing proxy voting procedures, but also provides a summary of common proxy voting processes used throughout the industry, and the relative benefits of each.  

Conflicts of Interest

The report takes a particular look at what happens when a conflict arises.  That is, when a board delegates proxy voting to the fund's investment adviser, but the investment adviser has an existing or potential business relationship causing a real or apparent conflict of interest.

For example, a fund adviser that also runs a pension business could be in the position of determining how a fund will vote the shares of one of the adviser’s large pension clients.  The potential exists for the adviser to make a decision based on the pension client’s business relationship with the adviser (or an anticipated business relationship) and not on what is in the best interest of the fund.  The proxy voting procedures approved by fund Boards often state that proxies must be voted in the best interest of fund shareholders, but determining the best method to identify potential conflicts of interest is typically delegated to the adviser.

Securities Lending

MFDF's report also lays out options available to funds and fund boards when dealing with proxies of securities out on loan.  Some choose to recall all loaned securities for voting regardless of the subject matter of the proxy.  Some recall only for material proxy matters, while others use a "litmus test" whereby they recall only when loaned securities constitute a predetermined percentage of the company's outstanding stock.   

MFDF's practical guidance makes clear that there is no one way for mutual funds to handle their proxy voting.  Rather, by using some basic guiding principles, the voting strategies and policies can be tailored for the individual fund and regularly reviewed to ensure they meet the fund's needs and responsibilities.