According to a report by Moody’s Investors Service earlier this year, passive investments account for 28.5% of assets under management in the U.S., a figure expected to exceed 50% in the next four to seven years.
What’s the driving force behind this passive investing trend? Passive funds – including ETFs, index funds, and quant funds – often have lower fees and superior performance over many actively managed, and more expensive, mutual funds. Passive investments may track indexes, such as the S&P 500, or be driven by computer-based models.
Passive investors are not interested in the quarterly communications cycle, are less responsive to traditional investor relation (IR) efforts, and have little interest in hearing “the story.” Increases or decreases to passive investors’ positions may be caused by changes in passive allocation strategies, including index inclusion or removal, or tracking quantitative models.
To incorporate the needs of passive investors into your IR strategy, you need to understand the fundamental differences between active and passive funds. Active managers have the freedom to buy and sell a stock in their portfolio if the outlook on the company changes. On the other hand, passive investors own the stock as long as it remains in the index, or it’s selected by quantitative analysis.
If passive investors don’t listen to conference calls, meet with management teams, attend conferences, or speak with sell-side analysts, then how can management teams engage with them? There are a few things you can incorporate into your IR strategy.
Understand evaluation metrics. To a certain extent, passive money is about governance, not about what sets a company apart. Passive investors leverage their proxy votes to express support or dissatisfaction with the company’s strategy or the company’s management team as a means to protect their investment. So, it’s important for companies to build strong relationships with these investors.
The key is to establish a relationship before passive investors voice their concerns. But it’s not always easy to connect. Make the effort to understand the metrics passive investors use to evaluate their portfolio companies’ governance structures and voting guidelines. Then make sure you analyze how these guidelines may differ from your company’s governance policies. Have a conversation about how you can get on the same page.
Know your indexes. Companies need to be familiar with the variety of indexes that include their stock, and be aware of key items that could influence inclusion, such as market capitalization or dividend policy.
Being aware of which passive vehicles are holding your company’s stock — and why — is an important part of the IR function. Index inclusions and exclusions can create big trading swings and sizable impacts upon trading volumes. If a company experiences a material decrease in its market capitalization, or a change in another metric, that company could be prone to exclusion from a particular index. In that case, the company does not have the option of presenting its fundamental story to the passive investor. This can be more pronounced for small cap companies.
Monitor third-party databases. Lastly, monitor third-party data about your company’s metrics so the correct financial information is presented on popular financial platforms, and your company’s stock is adequately screened for. Provide financial metrics that are standardized and comparable across companies.
The importance of traditional IR practices like ensuring that the information you provide to the investment community is relevant, accurate, and transparent will not go away even as your investor base changes. The recent uptick in passive investing has caused companies to rethink their approach.
Remember, your IR strategy should continue to evolve to remain effective and provide the greatest value to your company. For a personalized approach for managing your company’s investor relationships, feel free to get in touch.