Adrienne Baker gathers a group of experts to discuss how recent index trends affect IR
Recent trends in the index business are changing the way IROs look at these market measures. First, there has been a major boom in the amount of institutional capital, especially from pension funds, that is 'passively' managed. Brad Pope, head of US equity index product management at Barclays Global Investors, estimates that 30-40 percent of all institutional assets are now allocated according to various indices. And while pitching your company's stock to an index fund manager is like flogging a dead horse, IROs have no choice but to take notice of this large portion of institutional assets.Â
Then there's the raft of new sub-indices. Over the last decade, Dow Jones, Nasdaq, Wilshire, Russell, MSCI and FTSE have all sliced and diced world markets into a wide variety of sub-indices. From specialized indices that gauge certain market sectors, like the Dow Jones Internet Indexes, to stylized indices which track investment styles, like the Russell 3000 Growth Index, there are now a multitude of market measures to compare companies' performance. For IROs, these varied indices offer a broader selection of benchmarks to choose from. In other words, it's no longer a case of limiting yourself to the Dow Jones Industrial Average or the S&P 500 to find out how your company measures up. The question is, with all these specialized indices around, how should IROs choose an appropriate benchmark? And, is it possible to attract the passive audience of institutional and individual investors who put their money in index funds?Â
Meanwhile, investor relations professionals in emerging markets are bracing themselves for FTSE's and MSCI's forthcoming free float adjustments. By weighting the indices' component companies more according to the liquid portion of their shares as well as market capitalization, the index compilers are hoping to paint a more accurate picture and make it considerably easier for global investors to track the key indices.Â
To discuss these issues, Investor Relations gathered a group of experts including Pope from Barclays, Al Bellenchia, senior vice president and partner of Fleishman-Hillard, and John Prestbo, editor of Dow Jones Indexes and market editor of the Wall Street Journal.
Investor Relations: When did investors, both institutional and individual, start moving their assets into index-tracking funds?
Prestbo: It's been building stealthily over the past decade - like one of those overnight sensations that's been building for years. In fact passive investing began 20 years ago and reached a peak in the 1990s. On the retail side, one of the reasons it took off was because retirement plans in the US were changed by federal law, giving rise to the 401K. A whole host of mutual funds and index funds arose to service this particular demand.Â
Bellenchia: Institutional indices have been around for about 30 years. Professional money managers have always had to benchmark their allocations, so indices have always been on their radar screens. And with the recent growth in pension funds, indices have come under the public eye.Â
IR: IROs aren't pitching to index fund managers, but how can they communicate effectively with them?
Pope: There is definitely a prestige to being a part of an index. If you look at Bloomberg, for example, they provide a plethora of financial data with the ability to look up each company, which index they are represented in and their weight within that index.Â
Investor relations officers would probably work with the actual index fund provider, not the index fund managers. For example, if an IRO thinks his or her company's stock was misclassified, he or she would probably work with the index fund provider to communicate that message.Â
Bellenchia: The only things IROs need to discuss with passive managers are the mechanics of how they invest. For example, how their funds are going to work in terms of making portfolio adjustments according to the index. Also, if there is a spike in the stock price the IRO might speak to an index fund manager. But, in terms of material announcements, there is no point.Â
Prestbo: The only way an IRO would interact with an index fund manager would be in discussing a float adjustment. These days, all index providers, with the exception of the S&P 500, are adopting free float weighting. At Dow Jones, we define the free float at 5 percent, so anything above that threshold will be counted in the free float deduction of outstanding shares. It would probably be useful for IROs to have a dialogue with some of the market statisticians about their free float calculation.
IR: What happens when an index provider miscalculates a company's free float?
Prestbo: This is a problem. When S&P added Yahoo at the end of 1999, it went into the S&P 500 at its full market capitalization weighting even though half the stock was unavailable for trading. So here were these money managers with their S&P 500 funds chasing after these shares. The result was a big spike, and then the day after it was down again.Â
Bellenchia: IROs don't have direct contact with true passive investors. So the question they should be looking at is: How much of their company's equity should be in an index? And companies may or may not have a lot of control over the amount of equity they have in index investments.Â
Prestbo: A competent IRO knows every index that his or her company is involved in as well as what passive funds are based on those indices. They know their weight within an index and can derive a dollar amount of investment from the overall size of the funds. Once you have those channels of information, it's fairly easy to update them. That's really what it's about: finding out where your company's stock stands in terms of the passive investment community.
Pope: Then there are corporate governance issues, with IROs sometimes having a dialogue with passive holders if they were involved in a corporate litigation or corporate governance issue.Â
IR: With so many new sub-indices to choose from, how do you choose the best performance benchmark?
Pope: If I were an IRO making a presentation to senior management, I would use a broad benchmark, because people are familiar with those, and a style benchmark. For example, if I were a biotech company, I would use a growth-oriented style index like the Russell 2000 and then an industry-specific index that the company would hopefully be included in. The goal for the IRO is to show the entire picture and to define the discussion for senior management by focusing on the fact that there are broader benchmarks available today.Â
Bellenchia: Using indices to support various initiatives is an art and a science. Where the art comes in is in looking at other indices and modeling the performance of companies in them. In other words, comparing your own company's performance against competitors that are included in a given index. An IRO can also try benchmarking beyond strict indices and look at index-plus funds.Â
IR: Index-plus funds?
Prestbo: These are also called enhanced index funds - a gray area between pure passive investing and outright stock picking. A money manager models a portfolio on a particular index and then starts tweaking it and over-weighting or under-weighting certain stocks depending on the investment objective of the fund.Â
IR: Can IROs afford to ignore this world of passive investing?
Bellenchia: As an IRO, you should know the composition of your shareholder base, and there are all kinds of service providers that can help you with that. An IRO has to be able to react and provide intelligent feedback to senior management and other shareholders about the day-to-day activities of the stock. So, just because you have x amount of shares in passive funds doesn't mean you can ignore that percentage of your shareholder base, even if you can't actively influence their decisions.Â
However, in many cases, the best return for your dollar is to de-emphasize the amount of time you are spending on passive investors. And the best way an IRO should look at indices beyond the percentage of shareholder base is to use them as benchmarks to put their company in the best light.