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Nov 19, 2019

How IROs understand ETF rebalancing

In this new regular feature, IR Magazine asks three contributors to discuss how they respond when an ETF rebalances and it affects their index inclusion or – ultimately – their share price

Chip Newcom, director of investor relations at Equinix

At Equinix, three of our top five shareholders are passive index managers representing more than 20 percent of our registry. During the first half of 2018, Vanguard, our largest shareholder and also the largest passive investor in the real estate sector, rebalanced its real estate investment trust (Reit) funds from tracking the MSCI US REIT Index to the broader MSCI US IMI Real Estate 25/50 Index.

The change added tower Reits [vehicles that invest in the cell phone towers that underpin 5G technology], which represented 14 percent of the new weighting compared with 0 percent in the old index. Equinix subsequently dropped from the third-largest constituent in the index to the fifth-largest, and over the first half of 2018 Vanguard sold roughly 1.4 percent of our float.

Through the entire reweighting cycle, shareholder surveillance and regular updates to the management team were key. At Equinix, the investor relations team hosts a quarterly update with our chairman, chief executive and CFO to update them on major changes to our shareholder base. This provided a forum to explain why there was pressure on the stock and when the rebalancing would end.

During those six months when Vanguard rebalanced, our stock fell 3.8 percent while the S&P 500 increased 0.8 percent.

Samantha Cheung, executive vice president of investor relations at Sagicor Financial Corporation

I’ve had the benefit of working for companies at different stages in terms of their public market seasoning and index inclusion, ranging from a Canadian company at the IPO stage to a large-cap Canadian company that is well seasoned and a staple in multiple indices, and now a foreign company soon to list on Toronto Stock Exchange.

I believe most companies long for index inclusion – and it’s more important than ever given the explosive growth of ETFs and passive investing. Index inclusion usually means greater access to a larger pool of institutional investors and likely greater demand for your stock, resulting in better liquidity.

How to mitigate the impact of index inclusion or rebalancing

  • As new companies are included in indices, others will be removed. Management teams need to seek relationships or investments from a wide variety of investors to minimize the impact from index rebalancing or even exclusion.
  • Management teams should set key performance metrics that can stack well against a variety of indices to open opportunities to a wider set of potential investors, whether passive or active.

How to stay informed about requirements for index inclusion

  • Investment banking teams can be a helpful resource as their institutions often have professionals with specific strategic expertise in index inclusion.
  • Websites can provide a wealth of public information on specific index rules. Each index is different and, ultimately, decisions are made by the specific index committee.
  • Direct contact with the index manager can assist with understanding specific requirements and timing of reviews as each index is different.

Nisha Hasan, vice president of investor relations at Excellon Resources

When an ETF rebalances, often a substantial number of shares can either be bought or sold over a short period of time. When shares are sold, it can significantly impact a company’s share price, investor perception and confidence.

For these reasons, it’s important that IROs keep on top of ETF holdings. The most up-to-date detailed holdings and analytics are available on the ETF’s website, which is updated the following trading day. Rules for index inclusion and future rebalancing dates can also be found on the website or by contacting the portfolio manager – whom IROs should aim to know as, in some cases, if there is significant selling, he or she can answer questions over the phone or may be willing to sell blocks of shares to other buyers.

This insight is imperative when communicating share price volatility to senior management and shareholders who may be alarmed by large volumes of selling. While it can’t be stopped, concerns can be addressed and investors can be put at ease.

This article was published in the Winter 2019 issue of IR Magazine.

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The staff writers on IR magazine are from our team of highly experienced journalists.