Interconnection

“I must say as to what I have seen of Texas it is the garden spot of the world.”

Davy Crockett said it and left it at the Alamo. So we’re glad to be inside Austin’s city limits sponsoring the NIRI Southwest Regional Conference.  We doubt temperatures will be kinder than New York’s last week though.

There’s a pattern to what’s unfolding in the market and it impacts us. There’s also chapter tapestry to the investor-relations profession spread unevenly over the fruited plain and knitted in spirit, a durable comforter made hardy by decades and camaraderie. We’re wired to see the world as story. It makes those in this pursuit exceptionally adept at translation.  It’s what we do.

Just as our corps is animated by the inexplicable genius of humanity, a most complex and marvelous machine, so is the evolving investment landscape.  At root, human intelligence presses the button, and the machines thus run.

I’ve given this considerable thought in preparation for my TED talk Thursday in Texas. I’ll speak on market structure of course, but it’s more. An aside, make it IR duty to hear this TED video of 15 minutes from Kevin Slavin, masterful on market structure without meaning to be.

Current stock-market distress would move Rod Serling the impresario because it’s a Twilight Zone merger of Man, money and machines. It scares us. Right? We all live by the ticker (so to speak). Our profession is interlaced but now so is the planet.

Ever played poker? You pay twenty bucks for a stack of chips and you play till you win or you’re out. Suppose we floated the value of chips. Rather than a fixed buy-in, every table’s pot value would float versus another table’s, and all the dealers at all the tables would continually add to or subtract from chips in every player’s pile to balance out positions versus players at other tables.

This is what the world is doing with currencies. Money. You need to understand it in the IR chair. We borrow money from China and then depreciate our currency and depress our interest rates to zero so the impact of borrowing will be minimal. China then devalues its currency to keep from losing money on the debt we owe.

On Aug 12, the Chinese government devalued the yuan. There are some $500 trillion of interest-rate and currency swaps globally and if a big currency moves, it’s a de facto change to interest rates.  Investors and their counterparties underwriting rights were caught out. So during options-expirations Aug 19-21, markets fell.  This is Man at work.

Now we come to Exchange Traded Funds, the chief investment vehicle of the modern era. ETFs post positions every day by law. It’s inconvenient to continuously change share-holdings so they routinely use derivatives like options and futures instead, which is permitted by law. And machines modulate it. We last had a material stock pullback in 2011, last saw a bear in 2008. ETF assets have doubled since 2012. We have no idea how ETFs will act in a down market, frankly.

But we just got a clue.  On Aug 24, the new series of options and futures marketwide began trading – and markets imploded. What happened? We think demand from ETFs for options and futures was so poor that markets simply imploded at the open. Lack of demand is as big a price-setter as selling (put that on a t-shirt).

Today, everything is connected.  If ETFs, which are ephemeral supply or demand, stop using derivatives, it means indexes are faltering, which means you and I are getting wary in our 401k’s, which means fast traders are shy about setting prices, and all of it comes back to floating currency values, pontoons upon which global consumption dances in a delicate balance.  Nobody knows what’s real.

It’s not one thing.  And yet it is.  Humans don’t like uncertainty so they transfer its risk to somebody willing to pay to cover it.  Now that process is starting to reverse after seven years.

What we don’t know is who ended up with the risk. What we do know is that IR better be able to explain it.  That’s market structure.  Not story. So don’t miss my session tomorrow in Austin.

Showing Up

Investor-relations professionals are traveling salespeople.

Now, we’re not paid commissions and I can see some of you recoiling at the imagery of rumpled suits and satchels stuffed with brushes, a voice saying, “Excuse me, ma’am, do you have a couple minutes?  I’d like to tell you about our brand new…”

Woody Allen said 80% of life is showing up when you’d prefer to stay in bed. Ads play on satellite radio claiming 80% of sales follow the fifth to twelfth contact.  Whether those figures are real, my own sales experience boils down to a single word: Effort.

There’s an article today in the Wall Street Journal about venerable stock-picker Mario Gabelli whom many of us know because of the ponderous way Gamco Investors approaches investment-selection. You can’t quit after the first meeting.

When I was sitting in the IR chair years ago, the sales guy from CCBN – later bought by Thomson Financial and today part of Nasdaq Corporate Services – sold me more stuff than everybody else combined because he was always solving problems for me. He’d observe a need and say, “We could help you do that better.”

I’ve said before that Nordstrom has the best salespeople in retail because they’re concierges. They’re expert at assessing their consumers and matching them with the right products. They’re the unflagging herald helping you pursue sartorial superiority.

This too is the soul of modern investor-relations in a world where our core audience of active stock-pickers shrinks steadily, money like desert sand before the wind blowing to indexes and ETFs. Mario Gabelli despite good performance has seen $2 billion flow from Gamco this year.

IR is about matching product to consumer. We can speak in magisterial terms of the Liaison to Wall Street but at root IR is corporate concierge. We’re Nordstrom for Fidelity or T. Rowe Price, helping them dress well.  And everybody is looking for a garment because that’s what Wall Street does. Fund managers spend other people’s money.

Let’s get right down to handing out Fuller brushes. Say you’ve positioned your company as a growth story.  You craft a growth message, pinpoint growth drivers.  Every quarter you’re delivering financial and performance metrics highlighting sequential and yearly change, percentages metering growth.

But your stock is declining for whatever reason (and we’d know in market-structure data by measuring period-over-period change in behavioral flows no differently than you do with your metrics). Maybe it’s China, the sector is out of favor, the dollar is killing you.

The fact is you’re a value product.  Target growth money when your shares are declining and you won’t sell because the product doesn’t match the consumer. Growth money buys appreciation. Value money buys opportunity. Repeat that.  And there are shades of both. Momentum is aggressive growth money, deep-value high-turnover is aggressive value money. GARP (growth at a reasonable price) is your consistency constituency (say that fast three times).

Every IRO should be cultivating a deep palette of investor-relationships across this money spectrum. These are your consumers. You follow up – knock on doors because 80% of sales take a lot of persistence and if the stats are bogus effort isn’t – with the consumers currently matched to your product.

We produce data for prioritizing this relationship-management effort.  Our action items focus on relationship-management. For instance, you have a tough earnings call and your stock declines. Afterward, you ring top holders and reassure them. It’s protocol.

But wait with the salvo to well-informed prospects you’ve cultivated strategically. Watch the data. When your Sentiment is negative – all the tides of money are out and your short volumes are low – the likelihood your price will rise is high because the first buyer will lift price.

That’s the time to call just your deep-value relationships, the 4-5 you’ve built the past couple years. You have a product to offer these consumers. Highlight value drivers – not growth details. Tell a value story.

If they act, they’ll get an immediate return (call them next only when your product is right for them, and this relationship will become symbiotic).

And now you’re a growth product and story again. Call GARP and growth relationships because your shares will be rising. That’s what you can control. Turn it into an art.  You’ll be the best IRO on the Street because the goal is a well-informed and fairly valued stock (we have metrics for that too).

Remember, 80% of success is showing up. Over and over.

Dark Costs

Credit Suisse. Deutsche Bank. ITG. Pipeline. Barclays. UBS. BNP Paribas. Citadel. Goldman Sachs. Liquidnet. Bank of America Merrill Lynch. Citigroup.

What commonality unites these firms? All have been fined for violating rules on so-called dark pools, private stock-trading venues.  At least three are now defunct, Pipeline shutting in 2012, Citi halting its Lavaflow unit last December after paying $5 million to regulators for compromising customer data, and Citadel saying in March this year it would mothball its Apogee platform.

Morgan Stanley and JP Morgan have been investigated but as yet have had no knees capped in the twilight. This is no collection of backwater outfits but a brokerage Who’s Who. These firms are running your buybacks and underwriting your offerings, the pillars upholding equity market-making and liquidity for shareholders.

Ask any Vice President of Marketing at a public company how the firm’s products and services are sold and you’ll get an unhesitant response. But your CFO likely doesn’t know what a dark pool is or why the big brokers running them are continually afoul of rules. You’re the product manager of the equity market if you’re occupying the IR chair. You’ve got a golden opportunity (and in a sense a duty) to be the expert.

Word is ITG, a publicly traded firm itself and among the largest independent operators of markets serving as alternatives to the big exchanges, will pay more than $20 million to settle allegations of trading against customer orders in 2010. It’ll be a test for the company to survive a wallop of this proportion.

Citadel, the hedge fund founded by mogul Ken Griffin, has been fined more than 20 times for breaching various rules. A bad actor?  Visit the Finra newsroom (formerly the National Association of Securities Dealers, Finra is the watchdog for stock brokers) and you’ll see a continuous litany. In the past month alone Goldman Sachs, Raymond James, Wells Fargo, LPL Financial and Aegis Capital were fined tens of millions collectively for demeaning market rules. In May and June, Morgan Stanley paid $3 million.

If everybody is paying regulators, could it be market rules are like the tax code – so byzantine that everybody is routinely in violation? We could countenance a concatenation of penalties for fringe firms jobbing the innocent. But fines are the central tendency. It feels like Las Vegas when Bugsy Siegel ran it.  You’re gonna pay the vig. (We think regulators want to end dark pools. Since they created the rules – Regulation ATS and the Order Handling Rules – that birthed dark pools, they don’t want to reverse themselves. So they may instead penalize alternative venues out of existence.)

Why would public companies accept a market so complicated that Goldman Sachs can’t comply? It gets once more to the IR job today.  At minimum we should understand and measure its performance as we would any other market to ensure that our best interests and those of customers and shareholders are being served. If you want to sell in China, the market is big but what determines whether you can or not is structure.

“Dark pools” is an inaccurate term but if you’re an investor-relations officer you should understand them.  Exchanges like the NYSE cannot give preference and must post prices. They’re public markets.

Dark pools are not public. You need permission from the market’s operator to use one, and most don’t list prices for shares because the reason they exist is to escape a bizarre feature of the stock market: List a price and somebody will attempt to be above or below it in order to keep your price from being matched. Prices are today like the way a friend of ours in California describes using turn signals when driving: A sign of weakness.

So dark pools decide who gets to enter, and the products in dark pools like your shares are listed by amounts, not price. If a pool has 10,000 shares of XYZ, the price will be halfway between the best bid to buy them and offer to sell them in the public market. Ostensibly nobody knows I’m after at least 5,000 shares so I get more at a decent price.

See?  Now think about that. A mall brings people wanting to consume things together with retailers selling them.  In the stock market, complex rules make it challenging to find anyone selling what you want to buy, and the moment you lift a finger, the price changes (this is why your investors increasingly use ETFs and other derivatives – it’s too complicated to get big amounts of the underlying asset).

You say, “I’m a road warrior, a vagabond of highways and jetways, a troubadour of the corporate story. I don’t have time for this stuff!”

Have we got it backwards? Shouldn’t we first understand – and have a say in – the market for our shares before we market our wares?  (I fashioned that rhyme myself.)  Structure counts. Caveat emptor.  Latin but timeless.

Boards Should Know

We thought we were going to need a boat.

Driving into Kansas City, a torrent fell in such proportion that the sky, the landscape, the topography of the roadway, disappeared into a pelting gloom that had our wipers humming on high amid the beating din on the roof for 40 minutes.  Rarely has the first sliver of cutting light seemed so blessedly hopeful.

It had me thinking how darkness about markets prevails in the Boardrooms of America and investor-relations holds the light and the capacity to chase it out.  Boards don’t understand the market.  Perception about equity-trading is disconnected from data reality.

Across our client base reflecting $1.3 trillion of market capitalization there isn’t a single member not held by both Blackrock and Vanguard.  In most cases, the two rank in the top ten if not the five largest holders.  Below these are a sea of fellow asset-allocators ranging from the Powershares Exchange Traded Funds (ETFs) offered by Invesco to the explosion in so-called robo-advisors like Betterment and Charles Schwab’s ETF-powered Intelligent Portfolios.

This community claims to be “perpetual owners” – they hold things.  But if an investment vehicle has inflows, it buys.  Redemptions, it sells. If it tracks a market benchmark like the S&P 500, it relentlessly buys and sells to track movements.  Combine those two and the result is uniformity around supine volatility.

With a lot of volume. Bloomberg in a July article on ETF trading described how these derivatives of indexes drive dollar-volume of $18 trillion annualized now. The market’s most active stock is the ETF SPY generating billions daily and $6 trillion annually. Three of the four most active stocks by dollar-volume are ETFs. Derivatives are pricing the underlying assets.

Thanks to Michael Lewis’s riveting nonfiction thriller Flash Boys (and more), many understand traders in the middle are distorting outcomes. It’s worse.  Intermediaries are half the volume. Nearly three billion of six billion daily shares are chaff.  No ownership-moves, just cash in a register drawer for making change.

What’s a reasonable commission for service?  Real estate agents split 4-6% on home-sales.  Hedge funds want 2% plus 20% of profits. Your waiter will like 20% on a restaurant dinner. The government takes about 30%.

Virtu (Nasdaq:VIRT), a high-frequency trader deploying its own capital, had revenues of $148 million last quarter and net income of $77 million, a 52% net margin. Having no customers they charge no commissions. But sitting between they keep half.

When trading firms, or exchanges, or members of Congress, or regulators tout the benefits of low-cost trading, the proper response is to ask how a market can be efficient in which the middle men are responsible for half of all sales.  Groceries stores as middlemen for producers and consumers have single-digit margins, often about 2%.

What Boards should conclude is that somebody is getting jobbed.  But they don’t know.

Finra oversees 4,400 brokers. Yet in trade-execution data, 30 control over 90% of volume.  The reason is that rules require brokers with customers to meet defined execution standards comprised of averages in the marketplace.

The biggest brokers are handling order flow for the most active sources of trades:  Indexes and ETFs. So the biggest brokers define the standards. Since Finra fines brokers for failing to meet standards, smaller brokers route their trades to big brokers, who roll them up in algorithms powered by the central tendencies defining the bulk of their trade-executions.  That’s again the Massive Passives – indexes and ETFs.

Here’s a key to why 80% of stock-pickers underperform indexes.  Their trades are not setting prices.

And there’s little true “long only money” in markets now, because everybody hedges macro uncertainty related to globalism, central-bank intervention and floating currencies.  Data from Sifma and the Bank for International Settlements show currency, interest-rate, commodity, credit, equity and other swaps total $630 trillion of notional value, ten times global GDP. Any currency ripple can become a splash in the S&P 500.

Risk Management, Asset Allocation and Intermediation converge around borrowing – the amount of shares short every trading day. That’s 43%. Nearly half of all market-volume comes from borrowed shares, lent by big owners through margin accounts at big brokers, often rented by intermediaries to reduce cost and risk.

Only investor-relations professionals can report these facts to Boards. This is how you get a seat at the table. The only actions worth taking are ones planted in fact (and we can help you on both counts –measures and actions).  It begins with casting a bright IR light that lifts the shroud and defines reality.

Follow the Line

Money is better than poverty, if only for financial reasons.

So wrote Woody Allen for himself as Broadway Danny Rose in the eponymous 1984 film. I’m not sure what Allen meant then as I was a high-school sophomore wearing a mini-mullet. But there’s an application to IR.

Last week I had an intense exchange with an investor-relations officer new to the chair and moved over from the sellside after losing his job in research to advancing asset-allocation investment (This is Blackrock to Betterment, the translation of business strategies into squares on a Rubik’s Cube. These investors buy no research with commissions and listen to no earnings calls but track governance, meaning the biggest investors now are tuned more to rhetorical position than financial condition – I leave risk/reward ramifications to you).

Cognitive dissonance by definition is an inherent contradiction between evidence and conclusion. In Steamboat Springs it’s easy to match evidence to conclusion when watching the weather. If storms approaching from the south cross over Catamount Lake, you’re going to get showers on Mount Werner, the ski hill. Simple. No cognitive dissonance. You can see what’s happening.

But it struck me listening to this new IRO that he’d not drawn a line between his emigration from brokerage to corporate belfry. It reminded me of that lyric by Jacob Dylan, son of Bob and troubadour with the Wallflowers, who refrained plaintively how the same black line that was drawn on you was drawn on me and has drawn me in. Despite the origin of his demise on Wall Street, this IRO was certain active investors were pricing his shares. “Indexers don’t set prices,” he insisted. “They track active money.”

This view defies what we just saw from the NYSE where his shares are listed. When the exchange stopped trading for nearly half the day July 8, it was to make sure the closing cross – the ending auction setting prices for indexes and ETFs – would go off properly. The world’s greatest equity market sacrificed most of the trading day to one chronological exigency. And that’s because the most vital endeavor is tracking benchmarks – pegging the index. Getting the data right.

Follow the drawn line between diminishing sellside influence and the shift of equity research analysts to the IR chair and how the market functions. It’s drawn us all in to a 6th Avenue Heartache in a way, because what moved markets before doesn’t now, and if you suppose so, I refer you back to the definition of cognitive dissonance.

But it’s not sad! It just changes IR Best Practices – things we should all be doing. Our profession’s requisites must include comprehension of how prices are set so that the information you provide to management is accurate. Five rules:

Number One, high-frequency trading is a product of incentives paid by exchanges to fast traders to create valuable pricing data that exchanges can sell back to brokers. This is the No. 1 price-setting force (only half of intermediation is fast trading; the rest is from brokers working orders for customers).

Number Two, the buyside and sellside have spent billions over the past decade to disguise whether they’re buying or selling, so translating “block trades” into “long-only investing” doesn’t follow the money.

Number Three, the greatest force in the equity universe today is not love but asset-allocation. Blackrock and Vanguard. And they do price your shares routinely.

Number Four, more than 50% of your volume is the middle men (fast traders, brokers disguising orders) not actual investment. Factor that into your thinking.

And Number Five, there is little to no “long only” money anymore. Everybody uses a smartphone, and everybody hedges. Derivatives are a colossal factor because they represent risk-transfer and leverage and often (as yesterday in equities) price the underlying asset.

Connect the dots. Follow the money. Think. Okay, so money is no elixir and as Woody Allen said, it may be superior to poverty for financial reasons only (smile). But in the IR chair (and in politics) you should always follow it, because it’s the line of truth.

Behavioral Volatility

I recall knowing one particularly volatile fellow. I should have called him VIX.

Speaking of the VIX, options on that popularly titled Fear Gauge expire today as a raft of S&P components report results. Many will see sharp moves in share-prices and attempt to put them in rational context.

Volatility derivatives are no sideshow but a mainstream fact. Yesterday the top five  most active ETFs included the SPDR S&P 500 ETF (SPY) a Standard & Poor’s Depositary Receipt from State Street that traded 68 million shares, more than any single stock including Apple ahead of results, and the VIX Short-Term Futures ETN iPath (VXX), with 38 million shares, matching Facebook’s volume (out-trading all but seven stocks).

Louis Navellier turned the concept of volatility into quantitative analytics for investment at his Reno advisory firm managing $2.5 billion. Oversimplifying, rising volatility signals change. Mr. Navellier used increasing volatility as a signal to sell highs and buy lows.

By the same token, when your shares break through moving averages, it’s at root a volatility signal. Your price is changing more than the historical central tendency.  But what causes volatility?

This is why we introduced Market Structure Alerts in June for our clients. They’re predicated on the seminal principle that volatility signals change. Rising standard deviation is a pennant pointing to developments you should know. But we want more than surface answers.  Measuring tides alone offers no reasons. So we measure behavioral volatility, not price or volume volatility – which is a byproduct of the former.

When the ocean rolls or roars, we understand that it reflects something else ranging from the gravitational pull of the earth and the moon to earthquakes undersea. We use these facts to shape our understanding of how our ecosystem called earth functions.

A conversation I have often with IR professionals is what I’ll call Story versus Structure.  “My CEO wants to understand why we’re underperforming our peers.”  We have a simple answer and an elementary model that demonstrates it. Yet it can be hard to let go of the notion that underperformance traces to a fundamental feature, the Story. “Our return on equity trails our peer group, so that’s got to be the reason.”

Now sometimes Story is the problem. When it is, it manifests in behavioral change. But don’t forget that the biggest investors are Blackrock and Vanguard. We’re told they’re perpetual holders. No, they’re perpetual trackers of benchmarks like the S&P 500 so they are perpetually in motion, relentlessly sloshing like tides. When these tides crash more violently it’s because money in 401ks and pensions is uniformly beginning to buy or sell, producing disparate impact in stocks.

It’s not Story but Structure. The market functions in a defined way, according to a set of measurable mathematical rules, just like the universe. If we omit some part of market function because it’s complicated it doesn’t cause the behavior to cease to exist. Every IR program today should measure behavioral change.

How many ETFs own your shares?  Our smallest client with market cap of $200 million is in 14. Most are in 30, 40 or more, some over 100. Each of these probably has options and futures and tracks an underlying index, which also has options and futures. All the components of each ETF and underlying index likely have options and futures, just as your shares might. There are exchange-traded notes that directionally leverage indexes and ETFs. Swaps that substitute returns in baskets of these for proceeds in other asset classes. Traders pair futures with stocks and change them each day. And throughout, Blackrock and Vanguard and the rest of their asset-allocation kin behind two million global index products move like massive elephants ever crossing the Serengeti.

Sound dizzying?  It’s your ecosystem. The good news is we’ve reduced its complexities to a set of central tendencies and now we have Alerts that signal when these change.

Why should you care in the IR chair? We’ve got a friend who’s a realtor in Steamboat Springs. She knows everything about it, down to the details of any house you can mention that’s on the market. She knows which neighborhoods get sun in the afternoon, where you should be for easy access to amenities. She knows her market.

We want you to know yours. We hope to help you move from seeing price and volume as a tide moved by mysterious forces to understanding your ecosystem and what distinct behavioral change is behind volatility.

That in turn makes you a powerful expert for your Board and management team. You don’t have to do it, of course. But the quest to be better, to know what there is to know about the market you serve is the difference between something that can become mundane and an enterprise ever fresh and new, an exhilarating exploration.  Some volatility, so to speak, is refreshing!

Defend Yourselves

You need to defend yourselves as public companies.

This clarion lesson comes from last week’s trading halt at the NYSE though we think the exchange handled the outage correctly. Humans want pictures of perfection like Saturday’s Balloon Rodeo in Steamboat Springs. But don’t expect serendipity in securities markets. Your equity is the backbone of your balance sheet, basis for incentives, currency for investments. Know how it trades.

The root of the NYSE’s July 8 200-minute trading penalty box is the Flash Crash, a May 6, 2010 plunge and recovery in equities that spanned about a thousand Dow Jones Industrials points in twenty minutes.  During that maelstrom, trades executed at stale prices because timestamps on orders didn’t keep pace with market activity.

Now five years later, the exchanges are aiming for a July 27 deadline on two updates to timestamps mandated by Finra and the SEC. The new timestamps will calibrate to 100 microseconds are less, with one coming from orders occurring at exchanges, and the other timestamp for ones flowing through broker-operated dark pools relying on proprietary data feeds.  The thinking here is better timestamping will improve market-function and offer better future forensics. For instance, was there separation between exchange and dark-pool prices as occurred in the Flash Crash?

You don’t have to know this in the IR chair. But what if the CEO or CFO asks? It’s the market for your shares. There’s a great deal more to it than your story, a point made stark in a moment.

The NYSE claimed it had been testing timestamps and made a mistake in a deployment. Why test new code when the Chinese market is imploding, Greece is teetering on the Eurobrink and volatility is exploding in US equities – all of it interconnected through indicative value-disseminations for global indexes and ETFs that depend on timestamps?

Be that as it may, the NYSE handled the problem appropriately by stopping trading, cancelling orders and focusing on getting operations fixed in time for the closing auction. That in itself points to the larger lesson, which we’ll articulate in a moment. We heard lots of talking heads say “our fragmented market is a plus in crises because people could continue trading.”

The outage in fact demonstrated the opposite. We measured in NYSE data that day an 18% reduction in Fast Trading generally for NYSE issues, and commensurately higher investment behavior. In other words, with trading halted for half the day, speculators were less able to interfere with real investors’ moves.

By extension, we can infer with data support that much of what occurs intraday is effort by arbitragers to spread prices among securities that must track benchmarks – market indexes – by the time trading concludes.

Guess who supports that effort? The exchanges.  I’m not castigating here. But if you’re depending on information from an exchange (or its partner) to understand your trading, you had better darned well know how the exchange operates.  When the Nasdaq charges traders to buy shares at its primary market and pays them to sell at the BSX platform, it’s helping traders multiply prices and spreads. Do you see? Paying traders to engage in opposite actions incentivizes arbitrage. All exchanges pay traders for activity that’s got nothing to do with investment.

I’ll rephrase:  The exchanges fragment markets purposely in order to sell data and create transactional opportunities. It would be akin to your real estate agent encouraging others to bid against you as you’re trying to buy a house.

The NYSE’s trading halt proved that a fragmented market harms investors and helps arbitragers, because when it was closed for three hours there was less fragmentation and more investment – but lower volume. Volume often confuses busy with productive.

Don’t track volume without also metering what sets your price! Yet that’s not the Big Lesson for public companies.  No, it’s that the single most important pricing event of the day is the closing auction. And the audience depending most on it is the one tracking benchmarks (not taking risks like active stock-pickers).  Blackrock and Vanguard – the Asset Allocators collectively and by extension.

The number one force in your market is tracking broad measures, not weighing your earnings. This money is perpetually owning and yet constantly trading to match index-movement. You must quantify the price-setting actions of this colossal demographic group. If you don’t, the intelligence you’re offering management about what’s driving your price is almost certain to be incorrect.

Defend yourselves with an objective view.  It’s part of the job. Counting on exchanges is yesterday’s way.

Babbling Happily

Picture a mountain river still crisp with snowmelt babbling happily.

Now imagine a town on its banks. Suppose thousands of people jammed the waters congenially in every kind of flotation device, laughing and floating downstream. That’s Steamboat Springs CO on July 4.

But babbling should not describe your interaction with the Board when you offer an investor-relations perspective. It’s the season, with earnings upon us soon again. There’s been extensive discussion at the NIRI Forum about what to convey to management.

Your IR section should articulate why shares underperformed or outperformed in the focus period (presumably the quarter), strengths and weaknesses in your equity (distinct from your story), and expectations about future performance. Sure, explain what you’ve been doing, who you’ve been seeing, what analysts and others have been saying. I offered them too as an IRO.  But management values strategic contribution. You’re the product manager of the equity market – which all else from the balance sheet to incentive plans depends on.

One IRO included four slides on the stock’s structure some weeks after a pivotal earnings report.  The first highlighted strengths and weaknesses, summarizing:

Strengths. Active value investors are buyers, setting price. Asset-allocators are back, signaling a return of passive sector money, a core driver. Short volume is down 14%, risk-management is down. These signal renewed investor-commitment and lower risk, the purpose of communication.

Weaknesses. Investors were surprised by weak execution and sold reactively, and despite improvements in risk-management behavior over intervening weeks, it remains high relative to long-run averages for the stock. Investors are challenging us to deliver.

Let me explain risk-management. Do you have life insurance? It’s protection that comes at a cost. Money spent on mitigation is less to spend elsewhere.  Investors put money into your shares, which are a risk asset, and they insure them with forms of risk-management or hedging – options, futures, swaps, pairs trades, shorting. If they spend more managing risk, it implies uncertainty.

When it becomes more profitable buying and selling insurance on your shares than it is investing in your story, that’s the definition of “short-termism,” and it’s measurable and observable. If risk-management declines along with investment demand, investors are planning to direct less money to your shares in the future. They hedge what they hold and they stop spending money on hedges that aren’t needed.

Back to our example, the IRO also included a graphical representation of market behaviors before and after results, a table of key comparative market-structure metrics either side of results, and a slide that set forward expectations, which concluded unwaveringly: “(the ticker) is now a VALUE proposition and must deliver VALUE results first before it can again attract growth money that brings price appreciation.”

Don’t miss this point. The company considers itself a growth story. But with value money as buyers following a reversal, retaining base value in shares requires a focus on value drivers and value results – cost-containment, wise capital deployment, returns on equity and so on.  You know them.

Management teams often confuse the business with the equity.  If all the investors in the market were buying fundamentals, the two would be the same. But over 30% of market volume is asset-allocation. Blackrock and Vanguard don’t listen to earnings calls but they’re the biggest investors. To them you’re an equity product, not a business story. Intermediaries drive half your volume. They’re middle men. To them, you’re a product with appeal to different consumers.

Discount these factors at your own risk. Don’t just list accomplishments, news, coverage, investors, in Board reports. Present your equity market strategically. Wrap that information in powerful directives reflecting the reality of the product.

This is IR in the 21st century.  You’re not tubing down a river of roadshows and conferences, a buoyant stenographer. You’re a product manager. We have the data, metrics and experience to help you manage and message best.

Cans and Roads

The problem with kicking the can down the road is what happens when you reach a hill.

Speaking of hills, Taos wasn’t what we’d expected.  Galleries cluster the square, yes.  We loved our circuitous bike ride along the foothills to Arroyo Seco. El Meze boasts views, an iron-chef James Beard winner and delectable fare. The Rio Grande Gorge nearby inspires awe.  But you won’t find posh on La Placita at Paseo del Pueblo Sur. Julia Roberts bought Don Rumsfeld’s 40-acre ranch here to escape Rodeo Drive, not to replace it. Taos is backwoods, weedy, agrarian, a bit Baja. Signature dish? Fry bread at Ben and Debbie’s Tiwa Kitchen down the dusty street from Taos Pueblo, a Native monument.

Do you know what a whole life insurance policy is? It’s money for death that first builds cash value.  You might suppose there’s little connection to either Taos or investor relations. Conventional wisdom taught folks to “buy term and invest the difference.” Why blend your hedge with your investment? Insurance by definition is the price you pay for the unexpected, and investing used to be the opposite.

At Taos Pueblo, for a thousand years the people bested marauders with adobe walls and wooden ladders. The apartment-like construction permitted entry through holes in ceilings doubling as doors. If enemies breached walls, occupants pulled ladders and the complex transformed into an impenetrable fortress.

Today Taos Pueblo is a reservation with a casino down the road. Doors and stairs have replaced holes and ladders and the wall once 10-15 feet high is now a short decorative reminder re-plastered annually for the tourists. Residents count today on the federal government.

Whole life insurance is effectively what’s gotten the planet into trouble. A policy is an agreement to exchange value. Say $1 million. It’s a contract costing you a sum and guaranteeing you a million dollars if you die, which also lets you leverage the amount you’re spending but with immediate impact on the contract’s value. It’s a complex derivative. AIG offered them. The contract guarantees a return, so AIG got insurance on the insurance from a reinsurer and transferred the remaining risk to brokers like Lehman Brothers, which bought mortgage-backed securities to offset promises to backstop AIG’s commitments to pay life-insurance contracts a guaranteed return.

This all works fine until you come to a hill. Take Greece. So long as the value of assets – homes, stocks, bonds, art, commodities, on it goes – rose, everybody got a guaranteed return and one out of three people could work for the government and still expect to retire at 50 with a pension. That concept came to a chaotic halt when stuff stopped rising in value. Now we wait for a conclusion or a shoe smacked into the can rolling up the rising road.

For most of a thousand years Taos Pueblo ruled its domain and relied on nobody.  Today you take Camino del Pueblo north from Taos Plaza until it dead-ends into a dirt parking lot, where you pay a fee to visit.

What were they doing for a millennium that worked so much better? One could say, “No, Europeans showed up. That’s what stopped it.” Sure. The lesson that you’re better off relying on nobody stands, even if that means you don’t have doors and instead have holes in ceilings, and ladders. Is anybody paying attention?

Back to IR. Your shares today are a whole-life insurance policy.  They’re an asset with associated costs and capacity for leverage via indexes and ETFs, options and futures. All of it is interconnected.  Your story becomes secondary to liabilities and yield.  I’m sorry to tell you so but it’s a fact.  It must be part of what you explain to management or you’ll be leaving out the linchpin of contemporary capital markets.

History is predictive analytics.  The fundamental flaw in our global model is simple. You cannot guarantee a future without hills and if your model depends on kicking cans down roads, sooner or later the can will roll back to you.

The solution?  Simplicity.  Occasional inconvenience. Something a bit Baja. You may have to crawl through a hole in the ceiling. Cutting a door in the wall makes life easier but supposes risk is gone permanently.

We’d warned in May that June might be the roughest month since last autumn in what is our ongoing Great Risk Asset Revaluation. It was, though it took longer than we thought.  We’re not through this turbulence. We’ve reached a hill, of some sort.

Taos Pueblo still stands and its people are delightful and resilient as are humans generally regardless of whole-life insurance policies and risk-transfer. But tomorrow comes, and convenience costs. That’s today’s capital-markets lesson.

Being Novak

What moves you?

I gave it thought during ModernIR’s tenth NIRI National (I think 18 of them total for me now) at the Hyatt Regency in Chicago, here looking north across the river from the 33rd floor. It’s easy to fall into habits and skirt that unique brand of satisfaction bred in a job done well. We humans are given to routine.

Worn out after, Karen and I repaired last weekend to a resort on Arizona’s Carefree Highway, inspiration for an iconic Gordon Lightfoot tune, and were moved to tranquility despite the anvil heat. The desert offers a rich diversity of flora and fauna (extra points for spotting the cottontail) easy to miss in the confrontational brutishness of its mid-June exterior.  We embraced it and reflected.

To give our best we must be motivated.  A week ago in Chicago, we were clustered at evening with others in the Purple Pig, dining on that gastropub’s moving cuisine. We’ve done it twice now and relished both occasions. This one offered something special.

Space is a premium and so we were seated by another couple, kind and engaged youngsters by Karen’s and my estimation, a few years in age behind us (how time flies). We struck up a conversation.

I didn’t ask them if could share it so I’ll change names to protect privacy. I’ll call him Novak, her Andrea.  He was born in Serbia, then Yugoslavia, the son of wealthy parents who lost most everything when war erupted there in the 1990s. They came to the US.

Novak found real estate. What he lacked in language and knowledge he offset with motivation.  In realty then, the fax machine was dominating communication and Novak found a man to modify a PC circuit board so it could continuously dispense listings. He’d collect them all in the office and cut and paste and copy and fax, the PC dialing nonstop.

Of course faxing drove people crazy, both recipients and colleagues. But “every morning I had an offer,” Novak said.  He was a machine himself.  With indomitable motivation to be the best he became it, selling a billion dollars of real estate.

A buyer for a building he was selling was Andrea, and they married and now ten years later they have two children and a real estate development firm with a hundred people and millions in assets and they support a charity theater they created to perpetuate their own sense of what it means to be inspired and moved.

One of my favorite IROs talks about the line between what she calls “mailing it in” and setting oneself apart in our profession. If you’re not careful, investor-relations becomes repetitious. Quarterly reporting, annual reports, road shows, conferences, it runs together. You start dismissing new thinking as an affront to convention (this is true in politics too).

What’s the secret to fresh and new every day?  Being Novak. Finding inspiration that moves you to set yourself apart.

What thrills about market structure still after ten years is its never-ending novelty.  Today’s investor-relations officer must know Story, sure. But that’s just half the job.  The rest today is Structure – the way the market works. The knowledge of it is powerful and it breathes added vigor into the patterns of our profession.

Motivation. I remember when Tim Tebow tweeted that one-word anthem. We don’t all have to be Novak, conquering heights.  But learning market structure today is motivation – and since Structure is as important to price now as Story (yup, true), you’ll be enhancing your career.

And that’s uniquely satisfying.