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Passive strategies 'weaken' stewardship

11 August 2014


Active manager Threadneedle warns that large-scale move to passive management could negatively impact local authorities’ ownership mindset

Read more: Threadneedle passive management LGPS

Threadneedle Investments has warned of the risks to stewardship associated with compelling local authority funds into a large-scale move to passive investment, in its response to the UK government’s consultation on collaboration and cost savings for the Local Government Pensions Scheme (LGPS) in July 2014.

The active management firm considered a large scale move to passive management a risk that would weaken the ownership mind-set of local authorities and their ability to exercise real stewardship, systematically and effectively.

 

It also suggested that local authorities were likely to counter their ability to protect their own capital by aiming to avoid potentially value destructive strategies, such as certain merger and acquisition pursuits.

"There are important corporate governance considerations. Large, passive portfolios are more difficult, and more costly, to monitor, particularly when it comes to the resource-intensive engagement between institutional investors and company boards that is expected under the UK Stewardship Code," said Moira Gorman, local authority client director at Threadneedle.

"Active managers play an important role in the overall economy by actively intervening as stewards of investors’ capital."

Threadneedle also covered weighting risks it perceived inherent passive management, the value of active research and corporate governance considerations and the importance of active share.

The firm said that most passive equity strategies track indices that are market cap weighted, and therefore skewed towards large cap companies. It also argued that high quality company and security research is essential to successful and risk-aware asset management in both equities and fixed income, and should be the key factor in constructing portfolios that can deliver the desired risk-adjusted returns.

"There is an active skill to investing in bonds that judges the ability and willingness of issuers to repay debt, and where yields compensate for the underlying risk. Passive managers are ambivalent to this," said Gorman.

"Passive management is not a low cost panacea; it is one tool in an expansive kit that is available to pension funds to enable them to achieve their long-term objectives of deficit recovery and the payment of liabilities as they fall due," said Campbell Fleming, CEO of Threadneedle Investments.


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