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Dec. 21, 2020, 9:53 a.m. EST

A surprise about some ESG funds — they actually vote against environmental and socially conscious resolutions

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By Gita R. Rao

Investment in index funds has grown so dramatically that large fund-management firms now vote in an ever-growing proportion of proxies.  

Simultaneously, interest in ESG issues is greater than ever before. Index funds that focus on environmental, social and corporate governance are a way for investors to invest in accordance with their “values” at low cost, be it climate change or social issues. 

But how do these funds actually  vote  their proxies on ESG matters? This question has not been systematically examined. To gain a better understanding, I recently studied proxy voting over time by ESG index funds.

Also by MIT’s Gita Rao: Give mutual fund investors a voice in shareholder proxy voting

Through ESG index funds, passive fund complexes have the ability to encourage companies to move forward on a wide range of ESG issues, including labor practices, board diversity and the environmental impact of company operations.

In effect, this means that there are now two ways for shareholders to urge companies to move toward more “stakeholder aware” practices.

The first is putting actual investment dollars to work, and the second is ensuring that passive funds vote their proxies in a way that supports progress on social and environmental issues, and encourages corporate change that is consistent with the funds’ stated commitment to ESG objectives. 

The problem from both an academic and a practical perspective is that it is challenging to get a clear picture of how funds vote their ESG-oriented proxies. Proxy voting on resolutions is an essential corporate governance tool with votes for multiple funds on thousands of resolutions often reported in a single PDF, which can be anywhere from several hundred pages to over a thousand pages long — documents that are often too unwieldy to open on a personal computer. 

To better understand proxy voting by ESG index funds, I closely studied the voting records of several major funds, with the help of web-scraping techniques.

To begin, I chose two representative funds with a long history: The Vanguard Social Index Fund /zigman2/quotes/206180806/realtime VFTNX -2.58% and the BlackRock DSI exchange traded fund. The Vanguard Social Index Fund is the oldest and largest ESG index fund, with assets under management of $9 billion. BlackRock’s iShares MSCI KLD 400 Social ETF /zigman2/quotes/204173833/composite DSI -2.61% was set up in 2006 and has assets of about $2.2 billion.  

To study how the two funds voted, I worked with Quantbot Technologies, a New York-based hedge fund, to create machine-readable datasets, and manually classified shareholder resolutions into ESG categories from 2006 to 2019.

What I found was surprising — some might say shocking. Though both funds have an explicit ESG mandate, their voting records often contradict their stated objectives. 

For example, it is striking that the Vanguard Social Index Fund has voted  against  almost all environmental resolutions over the past 14 years.  The same is true of other socially conscious resolutions, including board diversity.

Below is the historical voting record for shareholder ESG resolutions: “For” is a vote supporting a proposed shareholder resolution, and “Against” being against it.  

What is being proposed in these resolutions? 

Digging deeper into the text of shareholder resolutions in 2019, both funds voted against proposals requesting “disclosure of board diversity and qualifications” at Apple /zigman2/quotes/202934861/composite AAPL -3.48% , Discovery /zigman2/quotes/200511275/composite DISCA -1.04% , Twitter /zigman2/quotes/203180645/composite TWTR +3.71% , Facebook /zigman2/quotes/205064656/composite FB -3.64% and Salesforce /zigman2/quotes/200515854/composite CRM -3.90%

That is despite Vanguard’s most recent statement that the fund has  “long believed in the importance of diversity in the boardroom.”  In fact, my analysis shows that the Vanguard Fund has voted  against  shareholder resolutions requesting  disclosure  of board diversity in every single instance since 2006. 

The Vanguard Social Fund voted against all but one social resolution in 2019, including a “report on sexual harassment policies” at Alphabet /zigman2/quotes/205453964/composite GOOG -3.05% /zigman2/quotes/202490156/composite GOOGL -3.26% and XPO Logistics /zigman2/quotes/205483484/composite XPO -4.00% , whereas the BlackRock DSI fund voted in favor.

Both funds also voted against a “report on the gender pay gap” at Alphabet, Bank of America /zigman2/quotes/200894270/composite BAC -1.24% , J.P. Morgan /zigman2/quotes/205971034/composite JPM -1.36% , Mastercard /zigman2/quotes/207581792/composite MA -3.47% , Oracle /zigman2/quotes/202180826/composite ORCL +0.93% and others.  BlackRock DSI voted for a “report on prison labor in the supply chain” at Home Depot /zigman2/quotes/208081807/composite HD -1.82% ; the Vanguard fund voted against the resolution here as well as at TJX /zigman2/quotes/203136811/composite TJX -3.12%

The analysis raises the question: Would shareholders of the Vanguard Social Index Fund feel that their values are being reflected, when the fund has voted in almost every single instance against resolutions merely asking for reports on board diversity, gender pay equity and modest environmental reporting over 14 years?

Shareholders in an ESG index fund should be able to see in a transparent manner how the fund has voted on all ESG resolutions, both current and past. They can then decide if the fund’s voting aligns with their preferences. 

For example, the State Street Gender Diversity exchange traded fund has voted against or abstained on resolutions asking for reporting on gender pay equity, sexual harassment and employment diversity at Mastercard, TJX and Home Depot. This appears inconsistent with the stated fund objectives and investors should be aware of the fund’s track record before they vote with their dollars.

While I do believe that most funds are thoughtful and nuanced in voting their proxies, more disclosure is necessary. For ESG index funds, this would ideally include disclosing votes cast and a statement of proxy voting policies. 

The potential for advocating from a stakeholder perspective is immense — and logical — given the long-term focus of these funds. Change, however, can only begin once there is transparency.

Gita R. Rao is on the finance faculty at MIT Sloan. 

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