It is well known that over the past 20 years or so, advances in technology and changes in regulation have massively affected how Wall Street works. Thanks to technology and deregulation of markets, unprecedented volumes of stocks and bonds now trade 24/7, around the globe, at the speed of light and the press of a button. In addition, technology and changes in regulation such as Reg FD have all but eliminated knowledge advantages, particularly for large-cap stocks, which have historically provided astute investors the ability to exploit market inefficiencies to achieve alpha in their portfolios.
Because of these and other developments, the investment landscape has changed more over the past two decades than perhaps at any other time since shares began trading on the New York Stock Exchange under a buttonwood tree on May 17, 1792. The result has created four trends that we think should drive a company’s investor relations planning for 2017 and beyond:
- The significant decline in commissions the buy-side now pays concurrent with their internal investment in often vast research teams has crippled their relationships with the sell-side. In the early 1980s, the average commission on the NYSE was approximately $0.25 per share[i].Today, current trading commissions are now 2.64₵ per share according to recent research by Accenture[ii]. This pressure on revenues has changed the economics of the stockbrokerage business, resulting in fewer brokerage firms supporting large research staffs covering small- and mid-cap companies, as trading fees no longer support the effort. Brokerage firms’ focus on providing corporate access is also getting squeezed, as the institutional investor is going direct to the issuer more often, or vice versa.
- Electronic trading is taking over much of the volume. Research suggests that as much as nearly 75% of daily volume bypasses traditional market makers and exchanges[iii]. Rather, it goes through dark pools and other mechanisms, making it very difficult to determine whether the volume is quantitatively (program) driven or the result of portfolio managers making active trading decisions.
- Money managers and the buy-side have not been immune from change either. Fund flows into low-cost passive investments (index funds, ETFs) are at their highest levels ever, as alpha is tougher to achieve and many active shops just fine-tune asset allocations around an index benchmark. With expense ratios of pennies, compared with a one percent or more on active funds, investors have rushed to passive vehicles. In the last three years, investors added $1.3 trillion to ETFs and passive funds while active funds lost $250 billion.
- Conversely, actively-managed hedge funds, which have been dominant participants of the many key active trends – small-cap investing, activist investment and M&A trading – have seen a significant outflow of assets. To date in 2016, investors have pulled an estimated $51.5 billion from hedge funds[iv], as under-performance relative to benchmarks over the past several years, exacerbated by high fee structures, have caused even the largest pension funds and other investors in these funds to rethink their strategies and allocate more funds to low-cost passive vehicles.
What does this all mean for public companies and their investor relations programs? Consider these four recommendations. They are a significant departure from where traditional investor relations programs spend the bulk of management time – on scripting around earnings, participating in sell-side conferences and focusing on corporate access that is driven by one-on-one meetings. While these activities remain important, they should be viewed in the context of a materially changing market environment.
- If the sell-side is less influential, step up your game on building and evolving your corporate story and operating descriptions through your own messaging. Create and publish quarterly Q&A that is well scripted, detailed and offers transparency (no matter what questions are asked on the conference call). Update and refresh investor presentations quarterly, and not just for the financials, to address market developments and the tweaks you are making in corporate strategy. Build “Company 101” materials that make it easier for a new investor to learn about your company and not rely solely on sell-side research.
- If passive funds dominate active, be smarter about your meetings with active investors by discriminating between true active investors and those who are glorified “index plus” investors. Accept there may be only 10-12 potential new active investors in your stock in any given year. Understand the knowledge and confidence gaps these investors will need to cross before moving into the stock. Lower the amount of time your management team spends on the road. Increase calls and updates with target investors. And, critically examine, and potentially pull back on time spent in cattle-call, broad reaching sell-side conferences.
- If trading is rarely dominated by active investors, train your management team and board to recognize the difference between quantitatively driven trading volumes and the few days a month when active traders may be involved. Rely less on stock watch or other services to help understand any given trading day’s activity and move to a longer-term outlook on share price and trading volume so as not to get into the game of predicting how market events may or may not be affecting your stock.
- If outflows from hedge funds are putting pressure on stock prices, prepare management and the Board for potentially heightened volatility in your company’s stock, particularly around earnings and other key events. Make sure management continues to focus on those elements that will drive increasing shareholder value, and communicate them aggressively. Ensure they are embedded in your investor communications, to the extent possible. Tie how current performance is the result of management’s business strategy, especially during periods of high M&A volume.
With all but the largest public companies losing research coverage from the sell-side and more funds flowing into passive investment vehicles, IROs and their management teams need to understand how the changing economics of Wall Street affect investing dynamics. On balance, public companies need to take more responsibility for actively building an audience for their stocks. Like any activity, and IR is not immune, it is vital to evolve with the times to remain relevant and effective, and provide the greatest value to your company.
About Clermont Partners
Clermont Partners counsels its clients on the broad range of issues and events companies face over their life cycles, including investor relations, reputation management, M&A, Activism and crisis situations. Supported by a research-driven process, our team creates tailored communications strategies and content to address key stakeholder audiences and advance our clients’ financial, corporate and reputational priorities.
With broad industry knowledge, deep capital-markets expertise and enduring global relationships with investors, analysts and related media, we advise our clients on both specific and ongoing complex communications challenges. We help our clients gain visibility into critical valuation drivers, identify and isolate the risks and opportunities to their brand and investment proposition, and develop strategies to help protect reputation. Clermont’s senior professionals are fully engaged in developing and executing all strategies and messaging content.
[i] Back In The Day, Brokers Got Away With Murder In Trading Commissions, Business Insider, 31 March 2014.
[ii] Trading Commissions: Rising Above the “Race to Zero”, 2016.
[iv] Here's How Much Investors Have Pulled From Hedge Fund in 2016, Fortune, 20 October 2016.