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Passive funds are playing an increasingly “active” role in takeovers

Passive funds which track an index, rather than being actively invested by a stock-picking manager, are increasingly influencing UK mergers and acquisitions (M&A) according to investment bank Jefferies.

Deals such as the £8.1bn takeover of engineering giant GKN by Melrose have shown that passive funds can play a key role in deciding whether the deal goes ahead, Jefferies said today in its latest M&A report.

This is partly because index-tracking funds are becoming more popular, meaning they own a higher percentage of UK public companies than ever before. But also a number of active shareholders had sold out of GKN in the run-up to the takeover bid, meaning that the company had a disproportionate number of passive shareholders.

Read more: As passive funds gain in popularity, we need active and opinionated investors more than ever

"The index funds on GKNs shareholder register played a significant role in determining the outcome of the bid," said Jefferies analysts in the M&A report.

"For example, Legal & General, a passive investor which held 2.6 per cent of GKN, is said to have voted in favour of Melrose, helping to push the bid over the minimum acceptance level."

Though passive funds may simply make their investment decisions by tracking an index, they do generally make an active decision in public offer situations which may not align with what the company's board recommends.

Read more: Engineering a big short: Hedgies build £1bn bet against Melrose

Due to this ever-important role which the tracker funds are playing, and their growing influence in M&A situations, Jefferies pointed out that the so-called passive funds must be able to prove they have good governance structures in place so they are making the right decisions for the companies they invest in.

On top of to that, Jefferies said the GKN situation showed the importance to UK companies of "building and maintaining a strong, supportive shareholder register, corner-stoned by blue chip active funds".

"Target companies cannot afford to take [passive funds'] support or abstentions for granted," analysts added.

The GKN takeover by turnaround firm Melrose, which was widely criticised by politicians who feared the buyer would cut jobs and break up the historic company, also hints at more wide-ranging trends in UK M&A.

After other stakeholders such as trade unions and major customer Airbus condemned the bid, Jefferies has said companies are going to start nudging such stakeholders earlier to say more in a hope that it will influence fund managers to vote their way.

Added to that, the pressure which the government came under to intervene in the takeover on public interest grounds – which is currently not a valid reason for intervention – will force ministers to look at the effectiveness of the Takeover Code.

Read more: "Nothing patriotic" about blocking Melrose takeover of GKN, MPs are warned

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