The rights of perpetual creditors

Equity shareholders do have significant powers, most notably the power to vote at shareholder meetings and thus the power to directly influence the appointment and remuneration of board members and senior management, as well as the outcome of share issuance and buybacks, mergers and takeovers. Conversely, bondholders do not, except (sometimes) in the case of bankruptcy or change.

However, there are four crucial points that can be overlooked.

1. Corporates have consistently increased leverage (and achieved falling credit ratings) over the last 30 years. They are not issuing fresh equity on the whole, providing less need to appease new equity investors.
2. Equity is perpetual – a seller is replaced by a buyer (although that buyer may be the company). This supports the case for stewardship in equity, particularly passive equity, where investors will be perpetual shareholders.
3. But large borrowers, with or without listed equity, are likely to refinance rather than repay debt. They will work to have liquid bonds trading in various markets, so they have as many sources of funding as possible. This means they are continually launching new issues, requiring engagement with creditors, and long-term holders of debt are likely to be perpetual creditors of these borrowers.
4. The recent pandemic has led many entities to borrow significant amounts of money from the government, the banks and the market. Not all borrowers will be able to repay this extra debt in the short-term and will have a greater need to consider the interests of bondholders for some years to come.

So, stewardship in fixed income is a position of significant influence for all borrowers, not just corporates.

Many indexation managers now consider themselves as long-term stewards of their clients’ equity capital (see our previous paper: “Investor stewardship: one hand on the wheel?). However, when asked, not one indexation manager regarded themselves as long-term stewards of fixed income capital. Further, they seem to conduct little to no engagement with bond issuers that do not have listed equity.

We find this disappointing given the considerable amounts of money in passive fixed income mandates, and also surprising given the increasing number of ESG-tilted fixed income strategies. Additionally, some of these large managers make great efforts to tout their stewardship credentials.

Improving Practice

Read the attached article where we set out steps indexation managers should consider to improve their stewardhip activity