March 19, 2014

Constituents

Is you is, or is you ain’t, my constituents?

If you know cinema’s Coen Brothers and the epically hilarious 2000 movie “O Brother, Where Art Thou,” you’re smiling. You remember the scene, the southern accent.

In geopolitics, a sweeping referendum last weekend reunited Crimea with Mother Russia but we heard nothing about the Latino vote or the union vote or the male vote. Demographics, we gather, weren’t crucial to Putin’s putsch. The constituents supporting secession were of a cloth.

Say you run a clothing retailer on the cutting edge of young fashion. Slicing your demographics with analytics drawn from your in-store inventory management system, you find that females aged 18-34 drive half your revenues. These are your core constituents, and you’ll concentrate on keeping them happy. But you realize too that growth takes more than one group. You craft a plan with products, advertisements and placement to expand patronage from other demographic segments.

The equity market has core constituents too. Your active holders, the ones who measure story and strategy. We divide them further with growth, value and growth-at-reasonable-price (GARP) characteristics, and often finer still.

Had we a marketplace where consumption of the product – your shares – was only about story and strategy, we’d call it a wrap and the movie would end. Yet this constituency taken together is still just one: Active investors.

Blackrock is the world’s largest investment manager. Most of its $5 trillion in assets are allocated not according to corporate story but around sector, industry and class. So what do we consider this indexed constituency? We at ModernIR call it Passive investment behavior or simply Indexes/ETFs.

While you don’t talk to these voters, they’re the unions of today’s equity market. They have big money and they get out the vote, so to speak. We’re concerned in our market-structure “polling” about how these constituents vote in your shares. You can’t control them – but they can control you. So it’s vital to know their sentiment.

These are two influential equity-market constituents – Active and Passive investors. The other two are Fast Money, or speculative trading; and Hedging. You can’t talk to Fast Money but the marketplace is built around them, wittingly or otherwise. When regulators required all exchanges to link and to let the first and fastest trade set price, Fast Money became the biggest price-setter – the independents, the swing voters.

Now, in your shares once again you can’t reason with this constituency – but you better well listen to it. Fast money is the fashion trend-setter. Fast traders identify what’s popular. They point to looming deals or activism with actions and reactions, and they highlight rotation, or real buying or selling. They are the harbinger of what looms. Call them Noise, but ignore them at your peril. We never short-change Fast Money. We track it as a doctor monitors cholesterol.

Last, there’s the fourth estate – Hedging. In a world of disappearing aircraft, magically manufactured central-bank cash, murky economic data and geopolitical dishevelment, everybody’s got insurance. Tomorrow, March 20, index futures expire, and with spring Friday comes the quad-witching rest of expirations. It’s not about puts and calls but trillions in swaps.

If you want to understand whether hedge funds are creating volatility, whether institutional holders see your shares as more or less risky than others, if the deal you just announced is likely to close or to encounter regulatory or competitive hurdles, the answer often comes in how traders and investors vote with Hedges.

That’s your equity market. It doesn’t matter if your market cap is $400 billion or $400 million. You’ve got four big constituencies setting your price and determining your market’s health. And it’s far simpler than seeing the marketplace as mass algorithmic confusion. It’s really not.

This is the simple secret to great IR in the age of demographics. Four big constituencies. They all matter, because they all have buying power and opinions. If you want to run a great IR program in this 21st century stock market, you best know your constituents – and not just the ones calling you.

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