Customs Street Advisors is a full service investor relations firm based in Lagos, Nigeria.

Institutional Inmates: What the Extinction of Retail Investors means for Companies

This week in Alrroya Aleqtissadiya, the United Arab Emirates (UAE) business and financial daily, I examine the significance for local companies of the inexorable shift in share register demographics to institutional investors.

In his keynote address at the UK Investor Relations Society’s April 2010 Conference, Xavier Rolet, chief executive officer of the London Stock Exchange, admitted that the LSE was under-serving retail investors. According to him, the UK market lags behind its European peers in the representation of private, retail investors and confessed that ‘it is much more difficult for them in terms of costs and the availability of electronic broking venues.’

What he omitted to include is the sheer scale of disadvantage that retail investors across the globe suffer when competing with institutional cash for first dibs in primary offerings, access to information and first rate trade execution, all of which combine to stack the odds against them. It is not solely a UK phenomenon. In addition to these environmental challenges, corporate issuers do not hide their preference for institutional investors with many having express share register engineering policies for attracting these investors.

As early as October 2007, Brian G. Cartwright, the former US Securities & Exchange Commission, coined the term ‘deretailization’ to ‘refer not only to the dwindling percentage of retail investors in some of our key existing markets, but also to the exclusion of retail investors entirely from some of the most important and dynamic new trading markets and new asset classes.’

Curiously, even as regulators across the world are putting laws in place to ensure that retail investors have access to information on the same terms as institutional investors and privileged entities, the de facto mechanisms of the market handicap them.

Yet it would seem that few companies in emerging and frontier markets recognize and are prepared for the consequences of deretailization. In these markets, which do not have a long tradition of activist and close-monitor investing, companies remain unaware of the demands that majority institutional ownership will place on them.

We will briefly consider the three most important pressures companies in these markets will face namely an increase in the surveillance of corporate governance, closer monitoring of corporate performance and thirdly, tighter issuer-investor relationships.

Although the jury is still out on the sustained commitment of institutional investors to the active supervision of boards, there is no denying the fact that when they do decide to become activist or privately press for certain actions, they can be an effective catalysts of change.

In the United States, the rise of proxy advisory firms like Glass, Lewis, Egan-Jones, RiskMetrics, and Proxy Governance have created influential pressure points on the voting decisions of institutional investors becoming important allies in proxy contests for both activists and boards. One expects that as the shift in ownership patterns moves in favour of institutions, they would either take a serious interest in the oversight of boards on their own volition and/or service providers like the proxy advisory firms, whose business model requires clients with significant blocs of shares to subscribe to their services, will appear to scrutinize board proposals and governance practices in public companies.

By definition and law, institutional investors as professional fiduciaries have a duty and ethic to monitor the performance of their portfolio companies. Since they do not have their own capital but depend on upstream investors to provide those funds, they are vulnerable to a shutdown if they fail to attain acceptable returns. They must ensure that their portfolios generate enough alpha to cover their administrative and trading costs in addition to providing a competitive return for investors.

Due to their non-negligible stakes, and hence much greater ability to affect prices by their buy-sell decisions, they can demand the attention of management to explain the quality of financial results and strategic business decisions.

It used to be that companies boasted about having several tens of thousands of shareholders. In a retail-focused market, this would necessarily be so. However, as ownership moves to more concentrated owners, such large numbers on the share-owner register would become a thing of the past.

Naturally, as the numbers of owners decline, with a weighting towards investors who own non-insignificant amount of shares, a good number of whom have been owners of the company stock since its IPO, the intimacy of issuer-investor relations are bound to become more intimate and hopefully, productive to the maximization of shareholder returns. In fact, we strongly believe that the prioritization of these relations will be the decisive determinant of capital markets success going forward, both for new and seasoned issuers.

Issuers need to recognize that the trend to institutional dominance on their share registers will place a bigger responsibility on them. There is a big difference between treating mail from an upcountry retail investor on the status of her share certificate or an email from an investor wanting to know if dividend warrants have been mailed, on the one hand, and the rigours of institutional owner inquiry, on the other. Are frontier market companies, like those on the Nigerian Stock Exchange, ready for the sea change? They better be.

The original article may be read here on the Alrroya Aleqtissadiya website.

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