Retail investors access equities directly, or through mutual funds. For those opting for the former, active ownership may be limited to attending shareholder meetings and voting in resolutions in an informed manner.
But for an increasing number of retail investors who access equities through the mutual fund route, the responsibility to act as an active owner falls on the mutual fund, on behalf of their investors.
Stewardship codes, like the Sebi’s stewardship circular for mutual funds and AIFs which took effect in 2020, provide a framework of engagement for institutional investors with their investee companies.
Stewardship codes require mutual funds to go beyond mandatory voting, and cover areas like disclosure of conflict of interest, ongoing monitoring of investee companies, and a policy for intervention, including collaboration with other investors.
Stewardship codes can be seen as counterparts to corporate governance regulations (to which listed companies adhere); while the latter aim to reduce friction between agents (boards and management) and principals (shareholders) in companies, the Stewardship codes aim to reduce friction between agents (institutional investors) and principals (ultimate beneficiaries including retail investors) in investing.
Good stewardship enables more efficient capital allocation, fosters better business practices, and can lead to long-term value creation. In a country where corporate governance issues are never far away, stewardship is a critical part of risk management.
Lastly, as ESG considerations become more important, active institutional engagement can contribute towards a more sustainable economy.
However, there are several barriers to stewardship. There are conflict of interest between the asset managers and retail investors. Asset managers may refrain from rocking the boat with the issuer, if the issuer is a large corporate client of the asset manager; according to Amfi, investments by corporations accounted for 46% of mutual fund industry assets in November 2020.
In a utopian world, investor interest would always come first, but employees are probably incentivised to put their own, and their company’s interests first. This may result in asset managers spending less resources on stewardship, which may improve their margins at the expense of long-term returns for their clients.
For many mutual funds, as for‑profit organisations, whether and how they adhere to a stewardship code comes down to incentives, or put simply, to return on investments.
Lucian Bebchuk, a professor at Harvard Law School, argues that “investment managers bear the costs of stewardship activities, but capture only a small fraction of the benefits they create.” This creates the issue of free riding, where some asset managers may have less incentive to allocate resources on active engagement with issuers if they receive the benefits from their peer group already engaging with the same set of issuers.
Mandatory stewardship regulations for mutual funds, with a focus on disclosures, are a good start. But without sufficient oversight, these regulations can potentially result in box-checking, or a superficial adherence to principles, with few concrete outcomes directly attributable to their stewardship efforts or benefitting their clients.
Can retail investors make a difference? Yes. Since fund managers have an interest in having their stewardship practices seen favourably, an increased recognition of the agency problems we described, and an awareness of the benefits of good stewardship, may drive demand for stewardship among retail investors.
This could induce asset managers to reduce the divergence between principles and practices and create a source of differentiation in the marketplace. The trend towards increasing institutional ownership of Indian companies has the potential to improve corporate governance and capital market efficiency. Stewardship is the key to translating that potential into reality.
(Sivananth Ramachandran, CFA, is Director of Capital Markets Policy India at CFA Institute. Views are his own.)