May 18, 2017
M&A communications in the age of ETFs
Communicating with robots might seem more the stuff of Isaac Asimov novels than of market-moving deals. Yet the rise of the exchange traded fund (ETF) has already had a profound impact on how transactions involving publicly-listed companies are planned and communicated, and dealing with them needs to be a cornerstone of any successful M&A communications strategy.
Successful investor engagement is vital for any significant merger or acquisition, especially contested transactions. Advising on that investor engagement is a key part of any communications strategy. And the higher the size of “passive” ownership by funds like ETFs, the more likely a company is to face a hostile takeover bid, according to research by Wharton finance professors. But if ETFs are top of the shareholder register, who are you going to call to discuss the merits of a deal?
There is no question that ETFs are increasingly popular among investors, attracted by lower fees, improved technology and returns that, in bull markets, are better on average than those achieved by active managers. A record $131 billion around the world poured into these funds in the first two months of 2017, according to consultancy ETFGI.
As with many investment trends, the switch has happened first in the US, but is gaining ground in the UK and Europe. ETFs, which aim to replicate the performance of a particular market or commodity, are bought and sold just like publicly-listed shares. Market makers create ETFs by giving custodians an underlying basket of stocks, and in return they receive shares in the ETFs. In the case of inter-sector M&A, a large ETF will almost certainly be invested in both companies.
In an M&A situation, you’re not going to be able to call up this particular fund manager for a chat – unless artificial intelligence gets really advanced. So what are the dynamics that strategic communications professionals need to consider as ETFs’ power grows?
First of all, share prices are likely to become even more volatile in response to news or leaks, as ETFs accentuate trades when they rebalance as an index moves. This makes a forced announcement by the market regulator more likely. For communications teams, this means it is even more important that we are prepared with effective leak strategies from the moment we know of a deal or even learn about rumors of one.
Second, those shareholders who are either genuinely active or activist will see their power and voice magnified, and may be the kingmakers even with relatively small stakes. This means that courting anchor shareholders who really understand corporate strategies is even more critical. So, too, is warding off potential activist issues at the pass. A deep understanding of your investor base, passive or active, is more important than ever.
To date, ETFs have largely voted in M&A situations based on the recommendations of proxy advisors, often ISS or Glass Lewis, so companies should be right up-to-date with which are most influential and what they are looking for in M&A situations.
Reliance on proxies is likely to remain the case with many fund houses, particularly for smaller transactions, but there is a shift towards more sophisticated engagement at some of the industry’s bigger hitters. State Street, BlackRock and Vanguard, the big three operators of ETFs, are all in the process of beefing up their corporate governance teams to engage with companies more actively. These players also have active funds, and their corporate governance teams work on behalf of all funds. While many still seem under-resourced compared to more traditional fund managers, they are at least able to engage more fully, and communications teams should endeavor to make contact with them to understand how best to get them on side in an M&A situation.
We should also remember that the march of the passive investment industry may not be as relentless as some of the more breathless predictions suggest. Part of the reason passive strategies have become so popular is the recent bull market (the second-longest ever in the US) and a period of unusually strong correlation between asset classes and across industry sectors, which has taken growing global instability in its stride. When the market becomes less correlated and the bull-run on shares ends, whether that be later this year or further away, stock picking is likely to regain popularity. When passive ETFs start under-performing in a declining market, investors might rediscover a fondness for active investing – which would be much more familiar territory for communications professionals.