The world of investor relations is changing and there are major challenges ahead, particularly for small- and medium-sized business, suggests RD:IR’s Managing Director, Richard Davies.
We live in strange times. As I write, the FTSE has reached record highs but, for those of us living in Europe, the world has not seemed as dangerous for many years. If you are not directly exposed to West Africa, the Ebola scare may have faded into the distance as quickly and quietly as the last outbreak of foot-and-mouth but we now have greater and even graver concerns. The sabre-rattling of the Russian state threatens the stability of European Union members in the East, and the savage chaos of the so-called Islamic State spreading ever wider across North Africa and the Middle East has even penetrated, according to recent reports, the southern border of Turkey.
The UK economy is growing strongly once again but uncertainty looms about the shape of the next government, with most polls predicting no overall majority. For the first time, political parties outside the main three could have a pivotal role in shaping policy, which the bond markets will not find encouraging. While much is made of the commendably rise in employment numbers, neither side of the House wants to talk about the thorny issue of the £1.5 trillion mountain of public debt, which has, on a non-inflation adjusted basis, risen more under five years of the Coalition than under the thirteen years of the last regime. European markets, encouraged by a vast programme of ECB quantitative easing, are currently performing strongly, even despite the threat of Grexit. However, despite the irrational ebullience, we cannot ignore the spectre of deflation which European bond markets tacitly forecast through the widespread purchase of negative rate instruments. Things will definitely get worse before they get better, fixed income fund managers now clearly believe.
We can, however, attenuate our concerns about rising currency risk for UK exports from stronger sterling by the thought of cheaper holidays on the beaches of Europe, particularly if Grexit goes ahead. That fine bottle of Château Margaux you have been coveting is getting cheaper by the day! Nobody expects oil prices to rise quickly any time soon and while this is good news for the users of oil, the fracking sector is looking increasingly desperate. Given the increasing evidence of environmental damage wreaked by this controversial process, some may see this as no bad thing. There is rich irony in Saudi intervention in oil markets producing a positive result for the ecology movement.
The world is becoming a more difficult place for the UK banking sector, facing uncertainty from the outcome of the next election and increasing public and regulatory scrutiny. Long established practices in the areas of research and corporate access are now under fire in the quest for greater market transparency, with the expected perverse outcome of finding funding for small- and mid-cap companies even more difficult. The regulator is now the prime source of market disruption, by dint of its breaking up of the historically opaque structure of fee payments between asset managers and stockbrokers. We are entering a new market paradigm of which the outcomes are as yet unknown, although most assume that independent providers of research and corporate access will take over an increasing share of business from the sell-side outside the bulge bracket.
Life for large-cap companies will go on much as usual in the new environment due to higher trading volumes justifying the supply by investment banks of corporate advisory services. Lower down the food chain, things will get more difficult. There are already rumblings of some big-name mid-market brokers ditching their corporate access departments and trimming back on their research teams significantly as they move to a near execution-only model. It seems likely that brokers will become sector specialists if they continue to have research analysts at all.
Stewardship and engagement
The grey area remains on the valuation of investor meetings in terms of their worth to investors. Fund managers still perceive there to be great value in meeting companies’ senior management – and not just to glean information not in the public domain, as many believe.
Stewardship and engagement are now viewed as an essential part of the investment process but some doubt that investor meetings are not really situations where price-sensitive information is disclosed on a selective basis. The assumption is that if investors rely so heavily on investor meetings as part of their investment research process, these meetings must by default contain the imparting of price-sensitive information to investor benefit.
While some canny hedge fund managers may well occasionally glean additional insights from senior management on the way to the lift, we all know that most investor meetings are mainly about providing the context to fund managers for the stock selection, as well as building a level of personal trust between investor and investee company senior management.
No amount of meeting technology such as video conferencing is going to change this attitude in the short to medium term. Given that the changes in regulation move the emphasis of responsibility in terms of payment to those receiving the benefit from those providing the service, it remains unclear how investors should value investor meetings in terms of monetary sums and as ever the regulator is unwilling to provide clear guidance, leaving open a potential regulatory minefield.
The idea that the market will find its own balance in this matter due to the emergence of new formations of access and research services seems highly hazardous.
The upshot for small- and medium-sized companies is they will increasingly have to pay for their own access and research, and install a dedicated IR professional to manage these services where one is not present (as in the majority of UK quoted companies at this time). Unless there is a deal in the offing, most brokers will not be interested in providing free services, if at all, to these companies, so they will become commoditised practices over time.
Active asset managers are still reeling from the massive rise in cashflows heading into indexed and quant products, including ETFs, as investors wake up to the disparity between charges and performance for many funds. Why choose a live fund manager when a robot can do just as well but for a fraction of the fees? UK fund managers are in a difficult place: they are no longer allowed to pay for investor access from client money; they may be unclear about the value they should apply to company meetings in their accounting; and some still believe that the market will go back to its old ways despite the imminent arrival of MIFID2 which gold-plates the actions of the FCA.
The life of the IRO will change as a result of the regulatory shake-up: there will be fewer market participants to deal with on the buy- and sell-side over time but there will be a greater demand on time to manage those that remain. Targeting, ongoing investor interface in a systemic manner and a greater emphasis on buyside analyst modelling will become generic issues and not just the domain of the large caps.
A long road ahead
2015 will be a year of significant change for IR in the UK and internationally as a result of the regulatory changes relating to access and research. We are only at the beginning of a significant restructuring of the market which will create new challenges to IROs in terms of handling of the communication and distribution of their equity story, and managing the demand for their shares in increasingly concentrated capital markets. Life will become increasingly more difficult for smaller companies, abandoned by capital markets not incentivised to support their growth. On the upside, the changes should mean an expansion in the number of IR professionals at smaller public companies. The marketisation of research is already creating higher quality analysis of companies, especially as new providers utilise the insights of deep data mining better to understand companies and the global competitive landscapes within which they operate. The marketisation of corporate access should encourage better quality investor roadshows, where the interests of the access provider/organizer are aligned with the company, and not the analyst bonus.
Like many other industries, investor relations, corporate broking and asset management are facing disruption on a major scale at home and abroad but unlike in other sectors, the disruption is being invoked by regulatory change, rather than new technologies and related market entrants. We know the route of travel but we may not yet understand so well the destination.