The rise of “passive/aggressive” funds in managing reputation

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What’s a believer in the importance of corporate reputation to think?  The stock price of the most recent poster child for bad corporate behaviour (Volkswagen) is racing back to pre-dieselgate levels. Yes, there were costs to VW’s business – tons of bad media, a CEO ouster, and $25 billion in fines so far.  But in 2017, VW sold more cars than any other manufacturer in the world.  And sales aren’t slowing down.

How can that be?  Don’t consumers punish companies that cross the line into unethical or criminal behaviour?  As reputation experts, we counsel corporate leaders on the importance of protecting their reputations to avoid destroying business value in just this way.  We talk about how “activist” consumers will stop purchasing products and services if they discover the brand has behaved badly.  So why aren’t people buying BMWs, Renaults and Fords instead of cars made by big, “bad” VW? Part of the answer is that consumers make decisions based on a range of competing factors like quality and price – and they have notoriously short memories.  But, if consumers don’t hold VW’s feet to the fire, do bad media and fines become just another cost of doing business?  Who will step in and ensure big, global companies will operate for the good of all stakeholders and not just shareholders?

The answer is fascinating: consumers are just one audience that can punish or deter a company that behaves badly or doesn’t meet our expectations for appropriate behaviour. Publicly listed companies also need people to invest in them, work for them and support their license to operate. Reputation matters because it drives people’s decisions to invest in, work for or otherwise support companies that they trust.

The rise of passive/aggressive investors

One stakeholder group that is emerging as increasingly influential are passive/index funds from investors like Vanguard, BlackRock and State Street.  Passive/index funds track major financial indices when making investment decisions.  One concern about passive/index funds has been that they are less likely than actively traded funds to incorporate environmental, social and governance (ESG) issues into their investment decisions.  Given that they are tracking a collection of stocks, passive/index fund managers can’t isolate and remove individual companies from the relevant index fund.  The fear has been, without the ability to punish individual stocks, ESG concerns would be downplayed as the big fund managers focused on performance of the overall index. 

The reality may turn out to be much different.  Passive/index fund managers are becoming increasingly aggressive about ensuring the companies in their basket of stocks incorporate ESG and other sustainable business factors into their long-term strategies. Each of the top three funds (Fidelity, BlackRock, and State Street) have issued policy statements outlining their stated intent to apply ESG criteria to their investment oversight activities. By working individually or collectively to influence board behaviour, these big passive funds have become much more active to encourage the companies they invest in to focus on long-term sustainable growth, including ESG issues. The rise of the passive/aggressive investor.

For example, BlackRock CEO Larry Fink’s annual letter to CEOs was reported and discussed widely last week. It has been heralded as a shot across the bow of publicly held companies.  Passive funds are watching how you engage with and treat your employees, communities, environments and society generally.  They will speak up and act to influence behaviour on behalf of their clients. BlackRock may ultimately still only care about returns, but the fact that they are taking a long-term approach to their clients’ interests means they can’t afford to not include ESG concerns in their approach. 

This is a good thing, but will it be effective? I think it will.  While they can’t isolate and remove individual companies from the relevant passive/index fund, they can exert pressure on corporate leaders to be clearer about their long-term strategy for success.  As Larry Fink writes, “The time has come for a new model of shareholder engagement,[1]” one that involves a year-round conversation rather than a once-a-year review meeting.

Smart companies realise that their long-term success depends on the support of the entire mix of stakeholders.  Their strategy incorporates an understanding and appreciation of the expectations and concerns of the full-range of business-critical stakeholders.  

As always, the proof will be in the metrics.  Do those companies that invite the outside world in – the ones that listen and adapt to feedback – attract the support of their customers, workers and wider society or not? Do they outperform those that don’t listen and learn? Increasingly, investors are betting that they do.

 

[1] https://www.blackrock.com/corporate/en-us/investor-relations/larry-fink-ceo-letter