In This Chapter

Mutual funds, along with institutional investors such as pension funds and foundations, own most of the outstanding shares of stock. This puts them in a powerful position to influence change, but they haven’t always taken advantage of their position. Socially responsible mutual funds have been upfront about their proxy voting policy and records. Traditional mutual funds, however, up until 2004, generally had no proxy voting policy and almost never disclosed how they voted their shares in the many companies they owned. Studies indicated mutual funds often just went along with management almost without thought. It was a rare case when a traditional mutual fund would challenge a management decision or proposal.

Prior to 2004, mutual fund shareholders had little understanding of the connection between the fund and the companies in which it owned shares, or whether the proxy votes were in line with the shareholder ’s values. Since 2004, funds are required to disclose their proxy votes, and the track record on voting for socially responsible issues (shareholder resolutions) has slowly improved. Regardless, most traditional mutual funds still choose to side with management on most shareholder resolutions, which is to say the funds either vote against the resolutions or abstain.

Mutual funds invest in stocks and bonds with a wide variety of investment strategies and styles. Socially responsible mutual funds are just one segment of a very large industry (8,000 different funds). The SRI funds, in most cases, work hard for transparency when it comes to their investments. As we noted in previous chapters, shareholders of individual stocks have the right to vote on important issues before the corporation. Mutual funds as shareholders of individual stocks have the same rights. For each stock a fund owns, a proxy statement is issued prior to the annual meeting. Prior to 2004, how most traditional mutual funds voted their shares was largely unknown to investors in the fund. In August of 2004, all mutual funds and later all investment advisers were required to disclose their proxy votes. Most mutual funds opposed this SEC requirement.

This provided a window into the operations of funds and how they used their proxy votes. In many cases, it was not a pretty picture.

Recognizing that traditional mutual funds may not have the same imperatives as socially responsible funds, it was still shocking to many investors how little thought was paid to shareholder resolutions and how easily fund votes went to management. As fund shareholders became aware of voting patterns, they began to question proxy-voting patterns. Even if a fund was not an SRI fund, investors saw value in supporting some of the shareholder resolutions offered to annual meetings of companies owned by the mutual fund.

Mutual funds own many different stocks and have the opportunity to look at a large number of proxy votes on socially responsible issues. It is not uncommon for an actively managed stock-based mutual fund to own from 30 to 100 different stocks. Index funds can own even larger numbers of stocks. This puts mutual funds in the position of seeing many different shareholder resolutions each year. A fund, like an individual shareholder, has three choices when it gets a proxy statement from a company prior to the annual meeting:

When most major mutual funds choose the first option, they give up the opportunity to play a role in change for the better, SRI advocates insist. Of course, the mutual funds may not see it that way. Some believe social or corporate responsibility issues are not matters for shareholders to decide—in other words, management is in a better position to judge the benefits of a particular course of action. One mutual fund frequently abstains from every SRI vote on the grounds that these are day-to-day business matters best decided by management. In surveying funds about their commitment to socially responsible shareholder

resolutions, researchers noted that the complexity of deciding whether a resolution is really a benefit or a negative makes keeping score difficult. A vote against a shareholder resolution may be the socially responsible thing to do in some cases because not all shareholder resolutions are brought by SRI investors.

The issue of how mutual funds voted (or didn’t vote) their proxies grew out of a concern by several SRI advocates who complained to the SEC. Their complaints were that the lack of transparency denied fund shareholders rightful information about what their money was supporting or opposing. Those advocating full disclosure noted it could be done easily and inexpensively by the funds. Their main argument, however, was that the funds had a fiduciary duty to shareholders to formulate proxy voting guidelines and follow through with reports on how they voted.

Traditional mutual funds resisted the change on several grounds, including the argument that shareholders really weren’t interested in this information. SRI investors proved that argument was wrong when thousands of letters supporting the reforms flooded the SEC. Some suspected funds were reluctant to disclose voting patterns because it might be discovered that they sided with management in an attempt to win retirement fund management business from the companies.

Industry observers noted that during this period there were numerous corporate scandals, although they were just the latest in a long line of wrongdoings. The mutual fund industry could be criticized for (or suspected of) conflicts of interest if this relationship between funds and companies continued. It is not difficult to imagine a mutual fund representative bargaining its proxy votes for a business relationship from the company.

The results of the reform have opened a window on how mutual funds fulfill their fiduciary responsibility with respect to voting their proxies. Of particular interest to SRI investors is how the traditional funds voted on socially responsible shareholder issues, ranging from corporate governance to environmental issues. This is important because it gives investors who want to invest in a traditional mutual fund, but are still concerned about SRI issues, a chance to see how the fund has voted on specific shareholder issues in the past.

There are over 200 socially responsible mutual funds, but that doesn’t mean every investor will find all of their investment needs met in this small part of the market. If you need to look to more traditional funds to fill your investment goals, but are still concerned about SRI issues, you can track how mutual funds vote on those issues. Some funds are very forthcoming with their proxy voting guidelines and voting histories, while others are much less so. Several studies found it was difficult to find someone who could speak knowledgeably about the fund’s proxy voting policy and voting record, especially in larger fund families. While the voting record of some funds was clear and consistent, other funds were more difficult to track because of seemingly inconsistent votes (this also is confounded by shareholder resolutions that may be titled the same, but have different objectives). Unless investors choose one of the few large mutual fund families that is open and consistent about its proxy voting guidelines and actual votes, it may be difficult to determine how a fund will likely vote on future issues.

Many investors look to large mutual fund families for their investment needs. These large investment companies have many different types of funds under one umbrella company. The advantage to the investor is you can often move your money from one fund to another without paying any fees, so as your investing goals change, you can adjust your investment portfolio. These huge firms are one of the first places many investors start when looking for a fund that fits their investment goals.

These huge firms have had a spotty record when it comes to disclosure of proxy voting guidelines and votes. Some are more forthcoming than others are. While finding the information is important, it is also necessary to review it carefully before investing if you are concerned about

how the firm may vote its proxies (on your behalf). One of the largest investment companies in the world is Vanguard. The firm has more than $1.1 trillion in assets under management and more than 183 domestic and foreign mutual funds of various types. It counts over 9 million institutional and individual shareholders, according to its website. With financial power like this, Vanguard could be a significant influence in the corporate world for change. But, like most traditional mutual funds, Vanguard doesn’t view that as its role or responsibility. Vanguard does a better job than many funds of listing it proxy voting guidelines, which outline what issues it believes are important and how it will normally vote on them should the situation arise in a proxy vote.

In general, Vanguard’s proxy voting guidelines suggest it supports efforts that add or protect the company’s value. It is generally supportive of many of the same issues that are important to SRI investors because they also make good business sense. These include:

When it comes to those issues classified as “corporate and social policy issues,” Vanguard takes a different approach. They view these topics as more “day-to-day” business activities and contend that a company’s management is in the best position to decide whether these issues are important to the fiscal well-being of the firm. Their policy states:

“Proposals in this category, initiated primarily by shareholders, typically request that the company disclose or amend certain business practices. The Board generally believes that these are “ordinary business matters” that are primarily the responsibility of management and should be evaluated and approved solely by the corporation’s board of directors. Often, proposals may address concerns with which the Board philosophically agrees, but absent a compelling economic impact on shareholder value (e.g., proposals to require expensing of stock options), the funds will typically abstain from voting on these proposals. This reflects the belief that regardless of our philosophical perspective on the issue, these decisions should be the province of company management unless they have a significant, tangible impact on the value of a fund’s investment and management is not responsive to the matter.”

Vanguard’s voting record on these issues, according to its website, is almost always to abstain. SRI advocates point out that an abstention is the same as a negative vote against the shareholder resolution (or a positive vote for management). SRI proponents also note that companies can ask the SEC to exclude shareholder resolutions that deal with “ordinary business matters,” so presumably if an issue makes it to a proxy vote, the SEC has determined it is not in this category.

None of this should be taken as critical of Vanguard. On the contrary, the company is one of the better mutual fund firms at disclosing its proxy voting policies and its actual votes. One helpful feature on Vanguard’s website is a summary of how the fund voted on broad categories of issues for the previous year. This summary gives the investor a quick look at how the fund responded to the various issues. Vanguard also provides a voting record by fund, which then breaks down the voting record for each company owned by the fund during the past year. This format is used by other mutual funds and while it provides a great deal of detail, it would be more helpful if it were summarized.

The increased disclosure ordered by the SEC has made a significant difference in the amount of information mutual fund investors have regarding the proxy votes the funds cast. But it is not clear that this transparency has measurably altered the voting outcomes of the funds as a group. It is possible that the potential for increased visibility has made some funds more thoughtful about how they voted, but it is also possible that any slight increase in votes for corporate or social issues have come as a natural evolution in the investing process toward embracing more socially responsible company policies and practices.

Corporate governance is a socially responsible investing issue, but it is also a big concern of traditional investors. Clearly, lapses in these areas have cost everyone money and scandals drained confidence from the market. In many cases, the traditional funds are in agreement with SRI investors on corporate governance issues such as making the board of directors more independent of management, not overdoing the compensation of executives, and other issues.

When it comes to social or corporate responsibility issues, however, it is a different story. In most cases, funds side with management or abstain from voting. In addition to the argument put forth by Vanguard in the previous section, funds have noted that many of the SRI proposals either lack sufficient fiscal analysis or do not demonstrate any material fiscal value to shareholders. SRI investors often argue that most of the socially responsible initiatives will pay a fiscal dividend at some point in the future. But this it is not the compelling evidence that traditional mutual funds want to hear as they are more concerned with how changes may effect a company’s ability to generate the level of expected earnings in the short term.

Traditional funds also note that one reason they invest in a company is their confidence in its management. When management opposes shareholder resolutions, funds will often defer to the managers as a matter of trust.

One of the highest-profile socially responsible issues is climate change, which is a broad term for shareholder resolutions that address concerns over global warming, greenhouse gas emissions, and other factors. The number of shareholder resolutions specific to climate change was at an all-time high for 2007. More companies are being pressured by shareholders and others to do something about their contribution to the global warming problem. Inaction at the federal level has not stopped some states from setting targets for lowering greenhouse gas emissions. Every developed country in the world except the United States has acknowledged this is a serious problem that is being made worse by human activity. As noted earlier, some companies will be convinced to take the appropriate steps without being pressured by shareholder resolutions or bad publicity, however, many still see planning for or dealing with the impacts of climate change as potentially added expenses with no obvious or immediate payback.

Many shareholders, including a significant number who would not consider themselves outside the mainstream of the investment community, will push companies to adopt policies on climate change and to back those policies with real operational changes where appropriate. As shareholder resolutions are brought to annual meetings, mutual funds will be asked to vote their proxies on climate change and other important corporate social resolutions. There are other important social, corporate, and environmental issues before corporations, but we’ll use climate change to illustrate how mutual funds have responded to a current issue.

This question is a significant part of the problem facing those who are concerned about climate change—a number of people led by government officials have simply denied that climate change is happening or that humans can do anything to stop it. The United States is alone among the world’s developed countries in not acknowledging the problems of greenhouse gases and the need to reduce their emissions. Of course, we are also the largest source of greenhouse gas emission on a per capita basis, so admitting that the emissions are a problem would put us in a tough position. Detractors suggest that to implement the controls needed to curb emissions might push the economy into a deep recession. Yet Europe and parts of Asia have already begun plans to roll back emissions to 1990 levels—thanks to alternative (to burning fossil fuels) energy sources.

In 2005, the CEOs of several major companies, including Ford, General Electric, Duke Energy, and others stated that climate change was a threat to the economy and some form of mandatory controls were needed to help us compete in a world market where carbon resources were shrinking. These aren’t wild-eyed radicals, but business leaders of some of the most respected industrial giants in the country. They are concerned that something needs to be done about climate change and it should begin now.

While climate change concerns can be about saving or protecting natural habitats, to many investors and a growing number of business leaders it is also about addressing real economic risk. If companies aren’t addressing these risks without prompting, shareholder resolutions are the next step. Unfortunately, proxy-voting procedures often guarantee that either the fund will vote against any shareholder resolution or it will abstain from voting at all. Mutual fund shareholders face another obstacle if the funds have a policy of supporting management against almost all shareholder resolutions.

The voting patterns of 100 of the largest mutual funds managed by 31 investment companies during 2005 revealed that none of the funds with holdings that received climate change shareholder resolutions voted for any of the propositions. Overall, the greatest weakness is proxy-voting guidelines that direct funds to either vote against or abstain from voting on environmental issues. The study was conducted by the Investor Responsibility Research Center for Ceres, which is a network of investment funds, environmental groups, and other public interest organizations. Ceres membership represents more than $400 billion in assets. Investor members include state and municipal pension funds, socially responsible investment firms, religious groups, union funds, and foundations, according to information on its website.

The Ceres study and others in the industry believe that climate change is an unacknowledged risk that investors should evaluate along with other traditional risk factors when considering a company for investment. Mutual funds, like all investors, evaluate the risk of an investment and decide if the potential return is worth the possibility that it will not meet its investment objectives. Missing or underestimating a risk can be devastating to an investor because it skews the risk-reward relationship. If an investment actually carries a higher risk than the investor calculates, the potential return he expects will not be sufficient (the higher the risk an investor takes, the more potential reward must be available).

If climate change is an unacknowledged risk as the Ceres study and others believe, mutual funds that dismiss environmental shareholder resolutions as a matter of policy are not fulfilling their fiduciary responsibility. By automatically voting with management (against) such shareholder resolutions or abstaining from voting, mutual funds are exposing their shareholders to unnecessary risk.

In many ways, Europe is ahead of the United States in acknowledging the risk of climate change and factoring in those risks to company planning and evaluation. Some industries at risk due to various consequences of climate change include:

Representatives of these and other industries and along with many financial professionals have taken the risks of climate change seriously. They are building risk models or adding climate change to existing risk models so that they can better evaluate the threat and discern a course of action. Investment professionals that accept climate change as a legitimate risk are working to help companies and investors figure out what the risks are, how to mange them, and what the potential opportunities are (if any).

Mutual funds that do not tap into this assessment of risk may be missing a key ingredient in evaluating a business. The blanket policies of voting for management or abstaining on socially responsible issues are irresponsible. Funds need to adopt a more open attitude that leaves room for them to consider shareholder resolutions rather than dismiss them summarily. Funds also need to push companies they invest in to fully disclose their exposure to climate change liabilities and what they stand to gain or lose based of how the company reacts to shareholder resolutions.

In a summary of a research post on SocialFunds.com, Jackie Cook, a senior research analyst with the Corporate Library, noted that an examination of proxy voting records from 2006 showed support by funds of climate change resolutions at less than 19 percent among traditional funds. Another study looking at a different grouping of traditional funds found support for climate change shareholder resolutions at less than 7 percent.

For SRI proponents, these numbers are perplexing, because they believe compelling financial justification supports steps to curb greenhouse gas emissions and other environmental actions that will help slow climate change. Yet most management teams are still opposing the shareholder resolutions and apparently not having success in negotiating with climate change advocates. Given the rising public tide behind this issue, it makes sense for businesses to address it head on and begin to formulate a response to the problem.

As more shareholder resolutions are brought to companies, more mutual funds will have to face their own insistent shareholders who will want to know how the fund voted and why. Investors are going to insist on a plan and strategy to move the company forward in response to what they perceive is a worldwide crisis. To the extent that companies and mutual funds ignore the warnings, they do so at their own peril. The time is coming soon when mutual fund investors (and not just SRI investors) will demand a much higher degree of accountability from the funds and the companies the funds own.

Most traditional mutual funds are posting their proxy voting guidelines and how their funds voted on their websites, although you may have to look to find the information. Some of the links to proxy voting information can be found under “investor relations,” or the “about (fund name)” link. If the site has a search function, the easiest path may be to enter “proxy” and do a search.