The Evolution of the Retail Investor and Sentiment Trading
In 2018, we wrote a piece on best practices to manage and communicate with the growing retail investor community. While the basic tenants of those recommendations hold today, the retail investor has fundamentally changed over the last couple of years.
As my colleagues noted a few weeks ago, a confluence of recent events have accelerated the impact retail investors are having on the equity markets to unprecedented levels. Gone are the days of the retail investors making long-term buy and sell decisions based on fundamental analysis or traditional valuation metrics. More and more, retail investors view stocks as highly liquid, short-term digital assets being traded on sentiment.
While healthcare companies were spared the retail-driven media frenzy surrounding stocks like GameStop, AMC, and Blackberry, COVID-19 has turned the spotlight on the global healthcare industry. Depending on where you sit within the healthcare industry, you have likely experienced the reality of the “COVID trade,” with stocks being whipsawed based on the daily sentiment surrounding the pandemic.
Below we outline a number of areas to focus on to better understand, and potentially benefit from, this phenomenon.
Be Mindful of the SEC Filings Retail Investors Are Digesting
This audience has become more sophisticated, particularly in their understanding of SEC filings. It is crucial to understand the “signals” created by certain filings. In recent years, analyses of quarterly 13-F filings, which show what qualifying institutional investors have bought and sold, have become easier to access by the retail community. This can cause sentiment to shift in and around the quarterly filings as retail looks to follow the “smart money,” both into and out of certain companies. If retail investors see brand name funds (affectionately referred to as “tuts” — short for institutional investors) exit a position, the assumption is there is a reason to be out, which may lead to retail following suit.
Along those lines, retail investors have increasingly looked to insider transaction announcements to make buy/sell decisions. Form-4s may not raise eyebrows among long-term focus institutional investors who know how to read and process these filings, but be mindful of the potential signals they raise for retail. Regardless of size, reason, or circumstance, any time an insider sells, the likely assumption is that the stock is overvalued, and any time an insider buys, the stock is undervalued.
Be Aware of Retail Investors’ Appetite for Sentiment-Based Risk
The continued elimination of cost barriers has created a completely frictionless market, which not only increased investors’ willingness to enter into the equities market, but also increased their willingness to take on more complex investments — including short positions and derivatives.
Taken together, there is the potential for significant volume-driven movements in stock prices as a result market dynamics, totally dislocated from the underlying fundamental performance of a company. Much of this is completely out of a management team’s control, which can be unsettling, but understanding the dynamics can help manage your and your board’s response to volatility.
Many healthcare company stories are highly milestone driven, so you have likely experienced some short-interest related volatility in and around key events (expected FDA approvals, clinical trial results, commercial adoption, etc.) as investors take bets against you. While unfortunate, these are highly logical and completely predictable occurrences. The challenges arise when trading shifts from operationally based decisions to being momentum- or sentiment-based. Retail flooding into short positions or actively going long on stocks simply based on their relatively high short interest has become commonplace. While the chances of your company becoming the next GameStop or AMC is unlikely, tracking your short interest can keep you up to speed on the overall sentiment in the market.
Other increasingly popular tools for retail investors are derivatives, in the form of puts/calls, as well as futures contracts. According to an article from Thomson Reuters, options volumes have ballooned in the recent past. In 2020, the trading volumes of options contracts hit an annual record of nearly 7.5 billion contracts, and the growing popularity among retail investor has contributed to the surge in volume.
Traditionally leveraged by institutional investors to hedge positions, lock in returns, or execute complex trades, derivatives are now viewed by the retail community as a low cost mechanism to generate massive returns based simply on the odds of a stock going up or down. In the same way shorts can cause volatility, derivatives can do the same. Derivative-related volatility can arise on specific dates during the year — specifically on days when the four major equity derivatives (stock index futures, stock index options, stock options, and single stock futures) expire. There are even certain days of the year when multiple or all of these expiration events occur on the same day (for extra credit, Google “Quad Witching”). However, derivative trends can impact daily price movements. With the availability of options volumes on specific stocks, investors may trade the underlying security (i.e. your company’s stock) based on the options sentiment, regardless of whether or not that volume is justified by your company’s performance.
Be Prepared to Take Advantage of Capital Markets Opportunities
One of the challenges associated with running a small cap public healthcare company is the need to raise equity capital on a regular basis to support clinical trials, new product development, commercialization efforts, etc. Your company’s cash needs are often highly visible, and the potential of an impending dilutive raise can keep investors on the sideline and put a ceiling on your market cap. While the uncertainty of potential share price volatility driven by the retail community can be unsettling, we suggest being prepared to take advantage of opportunities created by it.
First, make sure you have the ability to raise equity capital. Ensuring you have an active shelf in place will allow you to quickly jump into a potential deal.
Second, evaluate putting an At-The-Market, or ATM program in place. Once considered an unsavory method of capital raising, ATMs are now widely utilized — and for good reason. ATMs allow management teams to precisely control when and at what price they issue shares without launching a formal deal process, all at a relatively low cost. Particularly in this market environment, the ability to take advantage of inflated valuations on a daily or hourly basis to raise capital with limited dilution could serve as an effective tool for you.
The recent surge in retail investors has had — and will continue to have — a significant impact on the market. By better understanding this investor group and learning how to take advantage of it, you can protect your company while engaging this growing community. If you have additional questions about retail investors, please contact us.
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