Looking for Trading to Decouple

Several major financial publications have written about how investment managers are powerless to fight the impact of macroeconomic forces on equity markets, and how managing portfolios has become more difficult because of the sharply higher correlation between the performance of individual stocks and the overall market. During the past two years, correlations of 80% were reached and sustained for months at a time, levels not seen since the Great Depression. Particularly on high-risk trading days, fears of an extended global financial crisis and geopolitical turmoil have dominated stock performance to the exclusion of company fundamentals.

This trend has been exacerbated by growth in exchange-traded funds (ETFs), which mimic indices but trade like stocks during market hours. Notably a fund manager’s goal is to beat performance benchmarks, yet if performance is consistently in line with the benchmark there is an argument to forego active management in favor of low-cost alternatives. Higher stock correlations have sharply diminished the number of mutual funds able to beat their investment benchmarks, and even as the number of hedge fund startups has declined over the past five years the percentage of macro-driven funds has risen sharply against the number of stock-driven funds.

This scenario creates a challenge for investor relations professionals, particularly those involved with small-cap companies. Even though their carefully crafted positioning and use of vehicles to reach investors are sometimes overshadowed by the day’s headlines, and it is difficult to attract the attention of investment managers who are going macro to preserve returns in the near term, at LHA we believe it’s critically important to stay vigilant and focused.

As the global economy improves, the trading of individual stocks will decouple from equity indices as institutions seek returns over market performance through fundamental analysis and stock picking. In the meantime, here are some strategies intended to improve uptake of IR messages:

• Tie the story to a macro trend — if a broader economic or commodity indicator positively influences fundamentals, use it in messaging and incorporate this relationship into investor communications. This will identify a new opportunity for macro-focused investors.
• Highlight quality of earnings and cash flow, as well as reduction of risk — it goes without saying that a strong balance sheet, tight expense management and a P&L with leverage are required in a risk-averse environment. Without excessively looking in the rearview mirror, discuss incremental progress in these areas in particular during quarterly communications.
• Don’t sacrifice strategic vision — a company can become so focused on weathering the recessionary storm that management forgets to share its vision. Keep the main investor message centered on how the company is shaping its own destiny.
• Keep communicating — actively managed investment pools still need to hear good ideas for new investments, so pulling back on outreach and communications only diminishes a company’s profile in an already difficult environment. If you are interested in learning more about how strong financial communications can improve the profile of a public company, please give us a call.