Passive Resistance

Much has been made about the growth of passive investing.  Today, passive investments (index and exchange traded funds) represent approximately 37% of all assets under management in the U.S. up from 19% in 2009.

Pundits have raised several broad economic and social concerns about this growth, including:

  • Its effect on stock prices and corporate valuation;
  • The implications of the significant cross-ownership levels of passive investors on economic competitiveness, income equality, innovation and corporate investment in research & development;
  • Demand for the IPO of small companies that may not automatically become part of an index.

These are big questions that I’ll let market analysts, economists and philosophers tackle.  Instead, I want to address the implications of the growth in passive investing for investor relations professionals.

First, there is the potential impact on trading and valuation.  On any given day, its estimated index funds, quant funds and ETFs represent about a third of a typical stock’s daily trading volume. It’s also estimated another third of daily volume is generated by automated or high frequency trading.  So, combined, 65% – 70% of a typical stock’s daily volume is driven by programs, bots and algos – not company fundamentals – thereby increasing the correlation between and among individual stocks in a sector as well as with the overall market.

It also means fewer active or fundamental investors are setting price.  As a result, their investment decisions are potentially more impactful given so much of trading can be driven by non-company-specific factors.  Communicating your investment thesis, understanding active investors’ underlying styles and building relationships becomes more important.

Questions to ask:  What does your investor base look like?  What is the mix of growth, GARP, value or momentum investors, etc. and their investment horizons?  If existing investors exited your stock, who is poised to move in? What’s important to attracting these investors? Would a sector rotation change your outreach strategies?

Second, consider the implications of passive investors being your permanent owners.  They focus on both the quality of board and governance practices as well as how the company conducts its business (encompassing operating, environmental and social matters). This reflects their view that strong board oversight is the best way to protect and enhance their investment. Passive investors want communications that articulate and put context around a business’s long-term strategic framework and seek evidence the board is engaged and performing its fiduciary responsibilities.

While passive investors rarely initiate, they do hold boards accountable by actively evaluating issues raised by other investors and their internal and external proxy advisors. Their vote is critical as they often own between 25% – 35% of a typical public company’s outstanding shares.

So be familiar with the strengths and weaknesses of your company’s governance principles and practices.  Understand the governance priorities of your passive investors and the nuances of their views and voting record.  Consider conducting periodic outreach to stay abreast of their perspectives and build relationships before you need them.  Share your learnings with your board.

Wrapping up, don’t be passive about passive investors.  They will continue to play an important function in the markets for the foreseeable future.

  • Understand the behaviors of both your active and passive investors.
  • Develop a comprehensive approach to investor outreach.
  • Be cognizant of the implications for trading and valuation.
  • Think about the strategic importance of passive investors during an activist campaign as well as on matters related to environmental and social issues.
  • Balance your communications to address near-term expectations and results with your long-term strategic framework and corporate purpose as you reach out to all investor audiences.

 Lisa Ciota
President/Founder
Lead-IR Advisors, Inc.

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3 thoughts on “Passive Resistance

  1. Karine Stehle says:

    I simply must tell you that you have written an excellent and unique article that I really enjoyed reading. I’m fascinated by how well you laid out your material and presented your views. Thank you.

    Like

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