Passively Managed Funds
Usually, of the 25 holders in many companies, one or more are passively managed funds. Think of names like Dimensional Fund, Vanguard, and BNY Mellon. These institutions can own positions in many public companies, and in some cases, material positions. From an investor outreach, targeting and shareholder mix perspective, how should you think about these holders?
First: what is a passively managed fund? A passively managed fund is a fund whose investment securities are not chosen by a portfolio manager, but instead are automatically selected to match an index or part of the market. For example, the Vanguard 500 index fund is a passively managed fund that mimics the S&P 500 index.
Followers of passive management believe in the efficient market hypothesis. It states that markets incorporate and reflect all information at all times, rendering individual stock picking futile. As a result, the best investing strategy is to invest in index funds, which have historically outperformed the majority of actively managed funds.
Let’s consider how these funds make decisions and if investor relations can have any impact on their decision-making process. We call this the “Why Bother?” factor. Passive management or index investing is the opposite of active management in which a portfolio manager considers a company’s fundamentals and makes an investment decision based on a due diligence process of the issuers fundamentals (management, business model, sector, growth potential, competition, etc.).
What is the role for IR? The short answer here is that even the best of the best IR programs can have little impact on these positions.
Quant funds are characterized by their reliance on algorithmic or systematically programmed investment strategies. A quant fund can be one of many investment offerings supported by a large asset manager, or it can be the central management focus of a specialized investment manager. Quant fund offerings have been growing, and the business has become established in the industry. According to Investopedia, quant fund managers are responsible for roughly 27% of all U.S. stock trades.
A quant fund typically maintains a quantitative model and routinely screens for securities that fit the parameters of that model. Buy/sell/hold decisions are electronically driven and there is little to no fundamental decision making involved in the process.
What is the role for IR? Similar to passively managed funds, even the best of the best IR programs can have little impact on these positions.
Hybrid funds use an initial quant screen to determine stocks that merit a look, before being passed to a portfolio manager for further due diligence. Even giants like Blackrock have analysts and portfolio managers that actively manage some of their holdings. Knowing which funds employ fundamental analysis as a component of their decision-making process is critical. It’s essential to look behind the standard database labels of “Index,” “Quant,” or “Passive” next to the name to be sure that their investment in your company doesn’t get overlooked in your targeting process because the assumption is that it is owned in an indexed fund.
Electronic trading volume has increased substantially over the past 10+ years. Some estimates indicate that indexed trading accounts for well over half of all trading volume in U.S. equity markets. Other research suggests that as much as 75% of all trades worldwide are conducted electronically. Trading can go through dark pools and other mechanisms, making it difficult to determine whether it is quantitatively (program) driven or the result of portfolio managers making active trading decisions. On the flip side, hedge funds, which have dominated active investing trends over the past decade – particularly in small-cap names – have seen significant shrinking of assets and outflow of funds towards quantitative investing models. These trends have set the stage for the market to be impacted by the growth in passive investments.
How do we think about all of these kinds of funds from an IR perspective?
In general, there is little reason to be overly focused on the growth in passive investing and in the passive holders that make your shareholder list. However, there are a few things to consider in your overall outreach process:
- First, passive shareholders often care about matters of corporate governance, board structure, and sustainability. Because they are large holders with a vote at proxy time, being aware of how these holders will vote on critical issues is essential, particularly if you will have material items on the ballot at your Annual Shareholder Meeting. Firms such as Glass Lewis and ISS can be helpful in determining how an investor will vote. Knowing this upfront could enable you to open a dialogue with their governance or compliance department or advise your management team of the likelihood of the measure passing.
- Second, while you can’t eliminate or change a passive holder’s position, you can shift the mix of your top holders towards a more active investor base. Look at your 13F ownership (as well as 13G, 13D and insider ownership) and see what that mix tells you about who owns your stock. Having a large portion of your equity held by a few Index or Quant funds isn’t necessarily a bad thing, as on the whole, they don’t tend to sell off overnight based on a rumor. But they do rotate out of sectors; and if yours is up, it’s good to have a ready base of knowledgeable, fundamental investors looking for under-valued opportunities.
- Third, regularly monitor how your stock trades and look for trends that can generally impact indexed or quant-driven trading activity. Again, while you may not be able to control these trades, you can be informed for internal and external communications and rule out events that could be more fundamental in nature.
To summarize, here is a brief list of ideas to consider as you evaluate your program and plan a strategy for shareholder outreach:
- Target a broad range of actively managed funds; look at the ownership of your competitors and companies that share your fundamentals beyond just product or service offered.
- Increase outreach to smaller, actively managed funds, not just the big names.
- Compare passive ownership in your shareholder mix with that of your peer group.
- Monitor the passive funds that own your stock and try to reach out to them once a year; look for shifts in their ownership in your securities and those of your peers.
- Understand how your stock trades (volume, options, indices, etc.) can impact how your securities are traded and why.
- Know what indices your company trades on and which funds track those indices. This provides invaluable information when looking for the source of a spike in daily trading volume or a shift in passive ownership.
- Identify and pitch index creators who have discretion as to what companies are in the indices; at minimum, understand the criteria of certain indices, such as the various levels of the Russell Index.
- Reach out to major passive investors, if only to touch base with their governance or compliance organizations.
We work with many companies of varying sizes, almost all of whom have some component of their shareholder base comprised of quant funds, passive funds and hybrids. We have helped create shareholder targeting programs for dozens of companies with a diverse set of objectives. Contact us today to see if we can help you.
Leigh Salvo, Managing Director