In this article we will focus on the institutional investor and the basics of what your corporate reporting needs to achieve to make your company attractive to this type of investor.
What is an institutional investor’s focus?
Whether they work for a pension fund, hedge fund, mutual funds or a trust, their focus is on identifying investment opportunities that will improve the net worth of the portfolio for which they work. They are only interested in analysing whether the investment is suitable for their client’s portfolio and investment strategy. You need to tell the investors what they want and need to know, in order for them to make an informed investment decision.
What is their approach?
Their approach to investing will be the same whether you are a FTSE 100 or AIM listed company. In the current volatile equity market their focus may be investing in stocks that have strong balance sheets, good cash flows and good liquidity as a starting point. In a less volatile market, investors are likely to be less risk averse, providing the returns justify the risks, and thus may be more open to exploring other opportunities.
Institutional investors research each company using their own tried and tested formulas that are then applied objectively to all potential investments to determine the most attractive opportunities. They will typically look to model a company’s cash flow, earnings, etc. potentially many years into the future. Based on these models they will then work out what they think a share is worth, and the fair value of the stock.
This research needs to be repeatable across all sectors and economic cycles with the aim of providing investors with positive capital returns for the given portfolio maturity. However, you need to be aware that investors will have different investment objectives and time horizons.
Where do they get their information from?
In a nutshell, only they will truly know this. The key is to ensure your messages are clear and consistent across all media (i.e. printed and electronic communications). By doing this consistently over a period of time you will help to build and maintain their trust.
The company’s message, whether it be in printed form such as the Annual Report or the corporate/investor website, must lay out the key areas for a potential investor to understand the proposition.
Arguably the most trusted source of information on the financial performance of a company is the Annual Report (it will have been drafted and checked by the Board members as well as having to be independently audited). However this report forms just one piece of the jigsaw.
There are many sources of information apart from the Annual Report that will be used to evaluate a company’s economic potential, including face-to-face management briefings, market research reports, competitors’ data and trade magazines. Analysts typically have an industry focus so they will know much of the background to macroeconomic demand and competitive forces.
What are they interested in finding out about you?
It’s simple How much value can your business generate and do they trust the management to deliver? So all you need to do is convince them that they can get an acceptable return based on the perceived risk. (Easier said than done!)
But not easy! The expected return is a function of the risk to which the investor feels exposed. All things being equal, the greater the level of transparency in the information provided, the greater the level of trust, which should hopefully lead to a lower level of perceived risk.
Help them, help yourself Help them to put together the information required by putting the financial numbers in context. Some of the key things an institutional investor will want to understand include:
- your business model - the infrastructure, including the core capabilities and competencies necessary to execute a company’s business strategy:
- offering - the products and services a business offers:
- customers - the target customer, the customer relationships and channels of distribution; and
- finances - looking at cost structure and revenue stream.
Analysts and investors want to know about your position in your markets, including sales trends.
- your sustainable competitive advantage - how does your company differentiate itself from the competition making it more likely that customers will buy from you rather than from your competitors? Is this sustainable and repeatable over a defined number of years?
- where you are going - your financials may give investors an understanding of what you have done but you also need to provide a clear view and plan of where the company is headed based on knowledge of markets. Providing market information and an insight into the management’s strategy are highly beneficial in helping investors accurately assess the potential risk and put the financials in context. Is there a clear link between your strategy, KPIs and future goals throughout the report?
- your management skills - how does the management team stack up? Can they create and execute a sound strategy that will create value? Are they demonstrating that they are the right team to manage the risks adequately and ensure a healthy return to shareholders? It is worth noting that the quality of your financial reporting will also be considered as a guide to management ability.
Putting this all together
Take a step back. Think about what you want to communicate and about the interests of the investors you are targeting.
Do your research Think about your intended audience and the the type of information they will need to know to make an informed investment decision. Who are the institutional investors that are investing in companies with a similar profile to yours? What were the questions asked by shareholders at the last AGM? Are the same questions continuously being asked? If so, you may need to look at your message again and how you can answer these in a comprehensive manner. Corporate reporting is not about guesswork, assuming that the reader will "read between the lines".
Keep your messages consistent . . . unless, of course, there is notable reason for change.
Make it clear Is the narrative structured in a clear and logical manner? i.e. what you do, what markets you are in, why you are in those markets, your sustainable competitive advantage. Build on the facts. Note investor questions and answer them. What seems self-evident to you may not be translating in the same manner to your audience. You want investors to be able to make intelligent informed decisions on your company, and not leave them to "fill in the blanks".
Don’t Assume . . . While it is true that these analysts will already know the market they will be interested to know the management’s viewpoint and how their strategy was devised.
Make your key point . . .
. . . and then make your point again.
Present an honest and balanced appraisal Be honest in your view of the business and its strengths and weaknesses in the current market. Analysts and investors may perceive that your report is likely to be biased as management information may be geared to accentuate the positive while downplaying the negative. An honest and balanced appraisal of the market by management is helpful for investors. Analysts keep records of what you say so make sure you are confident that you can deliver . . . the City doesn't like surprises!
Control your message across all your media The Annual Report will not necessarily contain the latest market data, and is therefore not necessarily the best method for disseminating time-sensitive information. Investors want to be able to access the relevant information whether it is through an Investor Relations website or printed Annual Report. Your message will need to be consistent if trust is to be maintained.
So . . .
The more relevant contextual and non-financial information analysts have to support the financial data you have provided, the more confidence they will have in their economic projections of your company. Although their analytical investment models may be financially driven, if you can present your message in a clear, believable and structured way, where the risk is well understood, your company is more likely to achieve a fair valuation and attract your intended investor.