Make no doubt about it, there has been a sea change in the capital markets ecosystem over the past 18 months, and Investor Relations Officers (IROs) are being pulled along with it, whether they’re prepared or not. Just over a year ago, most U.S. based Investor Relations professionals, didn’t even know what MiFID II stood for (and many still don’t), and passive outreach was resigned to an annual one-sided dialogue around proxy season, if at all. In addition to MiFID II and passive investing, the continued importance placed on Environmental, Social and Governance (ESG) and the changing face of activism have all presented unique and challenging opportunities for investor relations departments as they prepare to plan for 2019 and beyond. While these changes will impact all public companies, the most severe impact is being felt by small and mid-cap companies, most of which do not currently have adequate resources to properly deal with these issues. Consequently, there has never been a brighter spotlight on the investor relations profession, and management teams and boards need to proactively challenge their current IR strategies to address these changes now to continue to deliver shareholder value, or risk being ignored by the broader investment community.
Much has already been documented about these topics, but this article is intended to provide an overview from the IRO point of view and hopefully provide a roadmap for how to effectively navigate these new waters. The views and insights contained herein have been gathered through scores of discussions with IROs, The National Investor Relations Institute (NIRI), sell and buy-side analysts, portfolio managers and, importantly, decades of personal experiences.
Let’s start with the Markets in Financial Instruments Directive (MiFID II), which was passed by the European Union (EU) and became effective on January 3, 2018. MiFID II imposes additional reporting requirements and tests on market participants in order to increase transparency and improve trade executions. It also places restrictions on inducements paid to investment firms or financial advisors by any third party for services provided to clients. Banks will no longer be able to charge for research and transactions in a single bundle, providing greater clarity while improving the quality of research available to investors. Brokers will have to provide more detailed reporting on their trades, including price and volume information, and archive all client communications, including phone conversations. Preparations for implementation of MiFID II have cost affected firms an estimated total of $2.1 billion, according to a report by Expand, a Boston Consulting Group company, and IHS Markit.
While the current rule is applicable to domiciled EU companies only, the nature of global financial markets has already produced a direct impact in the US which is only now beginning to manifest itself in the form of revised 2019 budgets. The bottom line is that most practitioners did not think it would pass, especially with Brexit looming, and little planning was done in 2017. The largest impact has been felt by small and mid-cap companies, as the number of sell-side analysts covering these firms has declined (some to zero), while research for all companies has been further impacted by consolidation. According to The Tabb Group, the buy-side has already cut over 1/3 of their research providers and research budgets have been cut in half. Naturally this has led to a direct reduction in the number of firms and analysts providing equity research and other services such as corporate access. While firms of all sizes have been affected, regional and specialty firms have experienced the largest reductions, and continue to be most at risk. This has left many small companies struggling to find quality research coverage and has placed an increased burden on IROs to increase their investor marketing resources as many sell side firms will no longer provide corporate access without direct compensation from the companies.
As the affects of these changes unfold over the next several years, it will provide unique opportunities for the surviving boutique firms, the stock exchanges and even the trade organizations like NIRI, to fill the void. Most small and mid-cap IROs are already stretched thin, and now they are being required to engage the buy-side directly while, at the same time, look for new sell-side coverage, just to maintain their traditional marketing efforts. One alternative today, that mainly exists in the micro-cap space, is company sponsored research. This approach has its own issues, chief among them, independence. For this to be a viable option in the future, the independence issues must be resolved and the practice become more mainstream.
It is conceivable for small and mid-cap companies to address many of these issues in- house but one complicating factor is time constraints. Most of these IRO’s wear multiple hats, i.e.,Treasurer, M&A, Communications Director, FP&A, etc., in addition to their IR responsibilities, and can hardly afford to adequately address these issues with their current resources. This leaves two viable options; hire additional skilled resources, or engage a third party, both of which require an increase in current IR budgets.
While the impacts of MiFID II are most keenly felt by small and midcap companies, the continued rise of, and changes to, passive investing affect all public companies. There is currently over $6 trillion invested through ETFs and this figure is expected to double in the next 4-5 years. The three largest “passive” firms (BlackRock, StateStreet and Vanguard) agree that the traditional definition of passive investing no longer holds true, as many fund managers are making active decisions to screen companies for their funds. Many of these decisions are based on metrics (ex. ESG) compiled by third parties that may or may not have been tabulated with insight from the companies themselves. Consequently, it is imperative for IROs and CFOs to actively engage in dialogue with these companies throughout the year, and not just as part of the annual proxy process. “Best-in-class” organizations are proactively establishing passive investor outreach programs as part of their IR strategy now to address generational shifts in investing that are expected to continue to occur over the next decade. The following excerpt is from Larry Fink’s recently published annual letter to the CEOs of the companies in its portfolios:
“Millennial workers were asked what the primary purpose of businesses should be – 63 percent more of them said “improving society” than said “generating profit.” In the years to come, the sentiments of these generations will drive not only their decisions as employees but also as investors, with the world undergoing the largest transfer of wealth in history. As wealth shifts and investing preferences change, environmental, social, and governance issues will be increasingly material to corporate valuations.”
Most companies don’t even know where to start, as many receive multiple boiler plate ESG surveys that require a massive amount of effort to complete, with a limited view into their return on investment. The best place to start is with a dialogue. Passive and ESG funds are willing to engage with portfolio companies, but they too have limited resources, and must rely on proactive outreach by the companies in addition to third party data. IROs must engage with these funds to better understand how the funds are constructed and to ensure they have accurate company information at their disposal. This will lead to more informed decisions around disclosure and transparency. The companies themselves will have to decide what to do with this information and make decisions about the cost/benefit of these disclosures.
Passive investing and a focus on sustainability is here to stay and will only continue to grow as millennials continue to move into the peak earning and investing stages of their careers; this is not a fad. Further sustaining this trend is the massive wealth transfer that is already occurring from the Baby Boomer generation, who is the wealthiest generation in history. According to research by Cerulli Associates, it’s estimated that 45 million U.S. households will transfer $68 trillion in wealth over the next 25 years. The vast majority of which will go to millennials and charitable organizations who favor this investing approach.
Activism continues to be in the news on a daily basis and has continued to take on greater importance as fund managers look to generate alpha in the face of pressure from passive investing. According to Sidley Austin LLP, the number of activist campaigns has increased almost 40% from 2017 to 2018, with the majority involving small and mid-cap companies. Corporate governance issues continue to be the top avenue for activists, but environmental and social issues are becoming more prevalent, and it is imperative for IROs to not only be up to speed on these issues, but to proactively prepare management and the board for the possibility of such a campaign. Importantly, IROs should have an open mind and proactively seek to work with and understand these investors instead of taking a more traditional reactive approach.
One of the more important changes to the activism landscape in recent years is the increased involvement of traditional long-only and passive funds. It is now common to see active involvement and support from these investors in activist campaigns. IROs should ensure they are working with these types of investors ahead of, and during, any activist campaigns, and not to assume they will side with management. If there was any doubt of this change, the following recent quotes should dissuade those opinions:
“Activist investors are increasingly seeking to partner with index providers when they campaign for change at public companies…“We take those calls all the time,” said Ronald O’Hanley, CEO of SSGA. “We are listening to good ideas.” – Institutional Investor, May 2017
“The role of activists is getting larger, not smaller, and in many cases their role is a good one.” – Larry Fink, November 2017
“Neither companies nor activists have cornered the market on great ideas that could generate value. Therefore, we believe company managements and their boards should exhibit openness, curiosity, and intellectual honesty with regard to serious, well-supported ideas for value creation, even when such ideas originate outside the company.” – T. Rowe Price, June 2018
The industry is in the early innings of these changes, and most are still in the on-deck circle, but there is no doubt that they have, and will continue to shape how companies approach their investor relations strategies. IROs and CFOs will be responsible for developing and executing these strategies, and many are not adequately prepared to tackle these challenges, as most are outside of the range of traditional IR competencies. The bottom line is that we all will be asked to do more with less, and traditional IR service providers are not currently structured to address these challenges.
This dynamic environment has opened opportunities for the stock exchanges, NIRI and a new breed of hybrid advisory/outsourcing firms like Asbury Investor Relations, to fill this void and offer curated, “outside of the box” solutions to current and future clients. To succeed and thrive in this new environment, companies must be open to exploring non-traditional alternatives and take a more proactive ownership role of their strategic messaging.