[Webinar Recap] The rise of passive investing

24 April 2019

By Marla Hurov

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How ETFs and technology are changing the dynamics of IR

Over the past decade, the rise of passive investing has been a defining theme of asset management. Though the capital markets may still be adjusting to the growing popularity of ETFs, institutional investors are rapidly driving an uptake in these investment vehicles. According to statistics from April 2018, passive US equity funds took $18.2B in inflows, while active suffered $11.4B in outflows.

With this significant shift from active to passive investment, IR professionals are looking for ways to impact the decision-making process of passive investors. When it comes to being included in these indexes, there’s also increasing need for disclosure around corporate governance policy, board structure and sustainability policy.

So how do passive investors make decisions and perceive a company’s equity story, and how can IR teams stand out in an increasingly data-driven world? In a recent webinar, Q4 partnered with IR Magazine to explore the nature of passive investment behavior, the key themes that interest these investors, the skills you need to be proactive, and how your company’s business decisions can affect whether you’re included in an ETF or index fund.

The panel of experts included: Mike Coffey, Vice President and Head of Solutions Engineering at Q4, Kirst Kuipers, Managing Director and Head of iShares at BlackRock, and Jennifer Almquist, CPA and IRC Founder at Ivy Street Advisory. Here’s a recap of a few of the most compelling insights.

The transformation of the investment landscape

Over his last 20 years of being a surveillance analyst, Mike describes the transformation of the investment landscape as nothing short of “incredible.” He explains that passive investments took-off around 2009, when Blackrock bought Barklays for $14B. Since then, Blackrock has developed into a combined market cap of $70B and passive investments have grown to become about 30% of all investments —  roughly a $13 trillion industry. In fact, Blackrock, Vanguard, and State Street are among the top ten holders of today’s stocks. To put that in perspective, Vanguard holds at least 5% of over 490 of the S&P 500 and there are actually more index and ETF funds than actual stocks in the entire marketplace.

Mike offers a little historical context: “We’ve gone from a simple Dow Jones industrial average to the first index for smart data, to ESG focussed funds and marijuana stocks. Traditional active managers have even established their own index arms. The first index trust, the Vanguard 500, has grown to $400B and is still growing. State Street launched the first ETF (known as the Spider) which now has $250B in assets.” He says that this growth has been driven by lower fees and the inability of active managers to beat the passive names.

Kirst agrees that the ETF business has become enormous. Blackrock itself manages $6 trillion in assets. “From the outset, it might look like a boring business with portfolio managers simply following an index, without really making any decisions. But for IR professionals, the most critical element to understand is which part of the index your company is or isn’t a part, as well as where you might fall out because of exclusions like ESG.”

Meeting the challenges of being included (or not) in an index

When it comes to IR professionals, Jennifer’s biggest piece of advice is: “Do your homework… and know thyself.” In a nutshell, it’s critical to know your company and investors. “Passive investors can’t get rid of your stock if it’s underperforming, which results in longer holding periods and engagement.” You need to consider factors that move the needle long term, like ESG. This underscores the importance for “understanding where your company belongs,” as well as what your company is doing to mitigate long term risk and how all of this is being communicated.

Kirst suggests getting started by following the largest players, including products and indexes, to “get a flavor for what’s out there.” The key goal of investors is to stay as close to their given index as possible. Regulatory trends have also made index investing increasingly popular. With MiFID II, transparency has been rapidly growing for investors, especially on the retail side. “You can expect index investing in retail portfolios to significantly increase, probably as high as 50% in the foreseeable future.”

According to Mike, it’s most important for IROs to know which factors affect their stock being included or excluded with passive investors. He explains, “given the growing amount of index ownership in each stock, it’s important to know why you’re in specific funds and when these files re-balance.” Every May, the Russell Rebalance ranks the largest 3000, 2000, and 1000 US companies by market cap. He cautions, “heading into this rebalance, you can see incredible volatility in your stock, as traders try to gain these moves.”  For example, you might move from a 2000 to 1000 ranking, which seems like all good news, “but you’ll see some big selling, because there are far less assets in a large cap than a small cap.” He sums up, “it’s crucial to know your largest index positions and why you’re in these funds and how they rebalance.”

Apparently, the word “passive” in “passive investment” is pretty misleading. It’s key for IR professionals to ensure they’re keeping up with passive investor behavior and engagement. Jennifer recommends leveraging the perspectives of third parties, “surveillance from vendors like Q4 has been great for my clients, in terms of giving them that heads’ up for a rebalance coming.” It’s essential to understand what funds hold your stock and what that means, in terms of how you are viewed.

Kirst adds, “ETFs are actually used by investors to make active decisions.” He advises IR professionals to keep in mind that investors use ETFs to get exposure to broader markets. It’s critical to have a good dialogue with index providers, specifically “the larger players.” While you can’t necessarily influence the indexes in which you’re a part, it’s critical to understand “what it takes and how you can avoid being excluded, especially when it comes to ESG.”

Corporate governance and ESG

Looking at corporate governance, Jennifer comes back to the importance of “knowing your investor and company” and then putting that knowledge into action. Passive investors expect engagement from companies themselves, so “make sure [they] understand your company and your ESG approach.” Whether you’re launching a cultural initiative or getting pressure from an activist, it’s “important to speak with the right investors and have a consistent voice.”

She advises aligning what you’re saying with the rest of your company and “make sure everybody is working from the same playbook.” It’s also crucial to “listen to your investors.” in terms of what’s top of their mind and where they’re coming from, so you can be proactive about addressing these questions and issues in your disclosure.

Mike agrees with the importance of being proactive: “Know the funds that own you and why.” He suggests leveraging a stock surveillance firm (like Q4) to help you keep track of the influx of new index funds, in real time. And once you establish your ESG game plan, get a leg up on your positioning by detailing your strategy and initiatives on your website.

Evaluating ROI on engagement with passive investors

According to Mike, “IROs can create huge value to senior management by getting ahead of index moves.” He points to following rebalances when they occur, so you know ahead of time if you’ll be removed from an index and can get in front of a decline in stock price. It’s critical “to be able to explain stock movement on a daily basis, including movements tied to indexes.” Track and prepare for stock movements, so you can always keep management apprised.

You also need to be able to draw the line between your strategy and your long term value drivers (ie. ESG). Jennifer says that being proactive with passive investors is key: “Understand where passive investors are coming from and the parameters of their investment.” In terms of messaging, she encourages IR professionals not to only rely on their IR team, but to take a broader approach by reaching out to other departments like marketing and PR, as well as company subject matter experts on value drivers like ESG, such as your company’s General Counsel, Head of HR, and operational managers.

Key trends in passive investing and the outlook for IR

Kirst says that for the larger institutional investors, governance is a key driver. Blackrock itself is focussed on creating long term sustainable value for investors. From ESG to SRI themes, he recommends “becoming relevant in more markets.” Start by looking at the largest index or ETF investors, and then evaluate where you are being included or at risk of being excluded. “If you’re at the tipping point for being excluded from these products, have a proactive discussion with your board about the implications.”

With ETFs now being more than 40% of all trading on the New York Stock Exchange, it’s critical for IR managers to understand their passive investors. Mike concludes that it comes down to “listening to your shareholders and investors, and making sure your board is aligned with their expectations.” While there’s not much you can do about redemptions or ETF sales in the marketplace, you need to “know your shareholder base, what makes up your index ownership and why you’re in there.”

If you suddenly become a value stock, you can expect to see ETFs buy and sell you. The key is always knowing where you sit as a company in these funds and how to manage these insights. After all, the mantra “Know thy company and investors” not only applies to passive investing, but to all walks of IR life.

Missed the webinar? Watch it now, on demand.

Marla Hurov is the Content Marketing Manager at Q4 Inc and blogs regularly about trends in investor relations, technology and digital communications.

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