Fund Managers Weigh Activist Role

Like millions of Americans, the typical stock mutual fund manager may be outraged by the corporate scandals that have rocked financial markets in recent months.

But should those managers be compelled to take a stand--with their shareholders’ money--against company executives who don’t appear to have investors’ best interests at heart?

The question is one the fund management business has faced periodically for decades. Now, in light of Enron Corp. and other corporate debacles, the issue is boiling up again.

Vanguard Group founder John Bogle is urging mutual fund companies to form a “Federation of Long-Term Investors” to push for change on corporate governance issues such as auditor independence; the dilutive effect of stock option grants on earnings; and aggressive accounting.

Bogle, in a recent speech, said the 75 largest mutual fund companies control 44% of the voting power at U.S. companies, including pension and institutional accounts. Combined, this “constitutes the 800-pound gorilla who can sit wherever he wants to sit at the board table” to demand corporate accountability or change the way firms conduct themselves, he said.

However, many mutual fund managers say the idea that they should get involved in pressuring companies is unrealistic. There isn’t enough time to do that while managing a portfolio, and to take the time to do it risks generating higher costs--and lower returns--for fund investors, some say.

“As a minority shareholder it’s awfully tough to get management to change,” said Bill Nygren, manager of the Oakmark and Oakmark Select stock funds in Chicago. “Most of the time the smart thing to do is sell the stock and move on to something else.”

Nygren likened investing to watching prime-time TV: “If you don’t like what you see, you can pick a fight with the networks or you can switch the channel. Most of the time we opt to switch the channel.”

Historically, corporate governance has been an important issue among socially directed funds and major public pension funds.

But the concept of institutional investors playing an activist role on key issues of corporate governance now may be resonating with more mutual fund managers.

In a recent letter to shareholders, Legg Mason Inc.’s star fund manager, William Miller, called on corporate executives to concentrate on their core businesses and stop focusing on earnings “gamesmanship.” He said company management spends “far too much time trying to massage analysts’ [profit] expectations in order not to disappoint ‘the Street.’”

Miller reportedly has assembled a group of fund managers who are considering placing ads in major financial publications listing their ideas of governance “best practices.” For example, the group might challenge stock option proposals it deems overly generous to employees at the expense of shareholders.

A spokesman for Miller at Baltimore-based Legg Mason declined to comment on the report, which appeared in the Financial Times.

Over the last 20 years, a few mutual fund managers at times have taken an activist approach with companies, either opposing management on certain issues or rallying other shareholders to press for change.

But those names--notably value-oriented managers such as Windsor Fund’s John Neff and Mutual Shares’ Michael Price--now are mostly retired.

Some industry experts say the time is ripe for more stock fund managers to make their voices heard, given the stunning losses many funds suffered in the collapses of Enron, Global Crossing Ltd. and other scandal-wracked companies.

B. Kenneth West, senior consultant to TIAA-CREF--the $271-billion-asset teachers’ retirement fund--and chairman of the National Assn. of Corporate Directors in Washington, said that in the long run, the nation’s continuing shift from traditional pension plans to defined contribution retirement savings plans such as 401(k)s, will spur mutual funds to become more active in addressing governance issues, especially if prodded by plan participants.

West said traditional mutual funds could be particularly effective in pressing for corporate governance reform. “They hold so much of the equity market and they don’t have an ax to grind,” he said. “You could argue that unions and pension funds have a political agenda, but mutual funds can be objective. For them it’s simple: Good governance leads to better investment returns.”

Yet whether there is in fact a meaningful investment payoff from governance activism remains a matter of great debate.

Bogle believes there is a link between good corporate governance and higher stock returns, as do many public pension funds and the socially directed investing industry, which screens companies based on issues such as the environment and workplace diversity.

TIAA-CREF, which spends slightly more than $1 million a year on corporate governance issues, believes it generates far more than that in added shareholder value.

According to New York-based Domini Social Investments, its Domini Social 400 index of large stocks screened for social and environmental criteria has beaten the blue-chip Standard & Poor’s 500 index over the last decade. The Domini index returned an annualized 13.8% in the 10 years ended Jan. 31, versus 13% for the unscreened S&P; 500.

But those long-term numbers have little relevance for many fund managers, especially momentum-oriented managers who routinely turn over their entire portfolios more than once in a calendar year.

Still, Bogle argues that funds that take a buy-and-hold approach to investing have a responsibility to become more involved in shaping corporate behavior.

He suggested that his Federation of Long-Term Investors start with six big index mutual fund managers that control an estimated $1.4 trillion, or 10%, of U.S. stocks: Barclays Global Investors, State Street Global Advisers, Vanguard, Mellon Financial Corp., Deutsche Asset Management and TIAA-CREF.

As passive investors who simply buy and hold stocks in indexes such as the S&P; 500, these investors in theory have a vested stake in promoting forthright corporate management to minimize the risk of more Enrons occurring.

“The only way an index fund manager can really influence shareholder value is through governance,” said Mercer Bullard, CEO of Fund Democracy, a Chevy Chase, Md., company that lobbies regulators on behalf of mutual fund shareholders. “These funds can’t vote with their feet [by selling their stake in a company], so they should be more involved” in monitoring their companies.

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Skeptics Say Some Reforms Not Practical

Los Angeles-based mutual fund giant Capital Group, famous for its long-term investing approach, also might be a charter member of the group he envisions, Bogle suggested. The firm will consider the plan when it receives something in writing, spokesman Chuck Freadhoff said.

Most of the index-oriented fund companies also say they would consider Bogle’s idea. TIAA-CREF, which is the world’s biggest pension fund manager along with offering indexed and actively managed mutual funds, said it would like to meet with Bogle on the issue.

Yet some index fund managers, such as Vanguard’s Gus Sauter, say that while Bogle’s proposal is well-intentioned, it’s hard to picture in practice.

“If you put us and all of our competitors in a room together we might end up debating Robert’s Rules of Order more frequently than anything else,” he said, referring half-jokingly to a popular manual on parliamentary procedure.

Sauter, who steers the Vanguard Index 500 fund and 24 other index funds, said Vanguard “has always been aggressive on governance issues,” and said he works to improve corporate practices as a member of various boards at the major stock exchanges and the Investment Company Institute, the fund industry’s main trade group.

Sauter said he likes to be involved in corporate governance--to a point.

“It’s not unusual for us to vote against a compensation package that seems excessive, or to meet with management to exercise our influence on a merger proposal,” he said. “What we won’t do is try to tell General Motors how to set up its marketing strategy.”

At a recent news conference, Investment Company Institute President Matthew Fink said he was “puzzled” by Bogle’s idea. Fink said fund companies already address governance issues individually, and he questioned whether the plan might face antitrust obstacles if, for example, managers end up voting shares as a bloc.

Bogle said critics may be reading too much into his plan. “This wouldn’t be like some sort of European Union, where you’re locked in and you have to follow strict rules,” he said. “All I want to see is an enlightened discussion of the issues.”

Some shareholder activists say that although their proxy proposals at corporate annual meetings still face an uphill battle when management opposes them, there are signs that such proposals are getting more careful consideration by other big investors.

At Walt Disney Co.’s recent annual meeting, a shareholder resolution calling for the company to stop awarding consulting work to the accounting firm that audits its books failed to pass, but it garnered 42% of the vote--sending a loud message even in defeat, according to activists.

Though Disney had opposed the resolution in proxy materials sent to shareholders, the firm did an about-face and supported the idea, making the final vote moot. Activists were heartened by the company’s shift as well as by the number of votes in favor of the proposal; they noted that most shareholder-sponsored proxy ideas historically have gotten few votes.

Nonetheless, some fund managers say widespread activism will never be practical for one basic reason: Most individual investors, they believe, would prefer to see their managers use their time to pick winning stocks and avoid dogs, rather than to badger companies.

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Fund Managers Learn to Pick Their Battles

With the majority of troubled companies, such as now-bankrupt retailer Kmart Corp., “There isn’t anything you could have done anyway,” Nygren said. “It was just a bad business plan.”

What’s more, if “the people running a company are really dishonest,” he said, “the damage they can do while you’re fighting a battle is huge.” In two months last fall, Enron’s stock shriveled from around $30 to less than $1 when the company skidded toward bankruptcy.

Nygren said he has picked just one fight in his 20-year career, pressuring Dun & Bradstreet Corp. to spin off Moody’s Corp. in 1998, and although he said he has no regrets (he still holds both stocks), the battle took much of his time over several months.

“These things can be all-consuming,” Nygren said. “With 60 holdings between the two funds, there’s no way we could get actively involved in all of them.”

However, he said, it’s overstating the case to say that fund managers generally don’t take corporate governance issues seriously.

Nygren said he votes on all proxy resolutions, for example, opposing excessive stock option plans as well as anti-takeover provisions that seem to serve management rather than shareholders.

“The general idea that institutional investors are shirking their responsibilities is misplaced,” Nygren said. “As I see it, my duty is to grow shareholder capital with after-tax returns that are as high as possible. Very rarely that means diverting my time to try to change the way one specific company is run.”

Bruce Veaco, part of the management team running the Clipper and PBHG Clipper Focus funds, takes a similar stance. “We will vote against management when warranted, but if we’re doing that consistently, what kind of a long-term partnership do we have with the company?” Veaco said.

He said corporate governance issues are part of the research process at Beverly Hills-based Pacific Financial Research, advisor to the Clipper mutual funds.

Veaco said he looks for related-party transactions in a company’s financial statements, which could flag a conflict of interest; examines the makeup of a company’s board; and frowns upon firms that re-price worthless stock options for executives, which “defeats the purpose of using options to align management and shareholder interests.”

Veaco said the Clipper funds will vote against excessive compensation packages, such as the stock option plan awarded to Mattel Inc. executives in May 1998. That management proposal passed with slightly more than 60% of the shareholder vote, and Clipper, which lost confidence in the leadership of then-CEO Jill Barad, later sold its shares.

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Shock and Anger but No Uproar Yet

Ultimately, Veaco said, “the best form of corporate governance is to identify and invest in companies with outstanding long-term track records managed by executives who have demonstrated a consistent commitment to building shareholder value.”

Shelly J. Meyers, Beverly Hills-based manager of the socially directed Citizens Value fund, said fellow fund managers she has talked to are angry about Enron and other unfolding corporate scandals, but still “in a state of shock.”

“There’s a lot of bitter sarcasm about all the executives at these sinking ships who made out like bandits and couldn’t care less about their employees and shareholders,” she said. “But it’s almost too soon for the uproar. Portfolio managers are doing a lot of knee-jerk selling and waiting to see what shoe drops next.”

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Times staff writer Josh Friedman can be reached at josh .friedman@latimes.com.