Crunching the numbers on mishandled corporate actions
Over $1 billion per year – that’s how much asset managers are missing out on through suboptimal decisions tied to voluntary corporate actions, according to analysis from Scorpeo. As the likelihood of rights issues and scrip dividends grows amidst economic uncertainty, how can asset managers limit these losses?
How have corporate actions been impacted by the pandemic and its fallout?
Economic uncertainty has had a notable impact on corporate actions volumes. Back in March and April, companies were rushing to shore up any capital weaknesses. This led to a spike in rights issues. Given the volatility, managers and analysts had to make some quick, informed decisions on whether to exercise those rights. They also had to grasp the potential impact on their existing holdings, given that rights issues dilute the values of those shares.
Conversely, economic weakness and uncertainty have led to a significant drop in dividends. The latest figures show a 22 percent drop in dividend payments in Q2, the biggest fall since 2009. Major companies like Shell, Boeing and General Motors have either suspended or cut payments. It is likely that we will see further reductions across a number of sectors. This will force a number of dividend-focused managers to make some sizable changes to their portfolio.
Our expectations are that, until the economic situation normalises, there could well be a continued demand to shore up capital, irrespective of how the underlying markets perform. We would also not be surprised to see an uptick in the volume of merger and acquisition activity, as some companies struggle to survive in the midst of continued economic uncertainty.
It is does not make good business sense for managers to lose over a billion dollars on an annual basis. So why is this happening?
Typically, it is an issue of awareness. Many managers don’t realise the amount of money that is at stake.
Additionally, other managers may not think it’s worth doing the analysis or dedicating the resource. For one manager, looking at one single decision, the missed value may be no more than a couple thousand pounds or dollars across their investor pool. That number is relatively small, but again, this is happening across dozens or even hundreds of issues. In an environment where active managers are fighting hard for every basis point, leaving cash on the table seems imprudent.
Regulatory and jurisdictional restrictions can also play a part. For example, index trackers may not be mandated to take anything other than cash to avoid weighting errors.
This economic downturn is the worst we’ve seen since the 2008/09 financial crisis. Did that downturn lead to a spike in corporate actions activity and, if so, what does that potentially bode for 2020?
Conditions in 2009 were similar to what we saw back in March and April. Almost every asset class plummeted and balance sheets were squeezed, forcing many companies to swiftly raise capital.
Back then, we saw a jump in voluntary corporate actions, such as scrip dividends and rights issues. This was especially true among energy companies, who were hurt by persistently low oil prices. Offering shares in lieu of the typical per-share payments was beneficial to companies who were temporarily cash-strapped. The same trend happened in 2014, after a sudden oil price crash.
It took about six months after the fall of Lehman for the wave of scrip dividends to kick in. This partially explains why we did not see a similar increase in scrip dividends earlier this year. If oil prices continue to remain low and debt issuance becomes difficult, a scrip issue will be more appealing to many energy companies.
That all being said, increases in voluntary corporate actions puts a strain on analysts. Voluntary corporate actions require a decision to be made. Analysis needs to be done to determine the best course of action for shareholders. Analysts already have busy workloads and during hectic market conditions, they are often pulled away to support the business in other respects. Without the time or resources to properly conduct this analysis, asset managers may be at risk of making inopportune decisions.
Is that another way of saying that managers stand to lose money?
Using the scrip dividend as an example. A scrip issue comes with a default choice: continue with the cash payment. Managers that let the election deadline elapse with no decision will automatically get the cash. Our analysis shows that this is the more common route, with 75 percent of managers receiving the cash.
Yet, it is not the most favourable one. In many instances, the share election is more valuable than the cash option. One stark example is the National Grid dividend issue in May 2019 – here, the stock election was far more optimal than the cash election, representing a 48.1 pence-per-share advantage. Yet even with the value being so clear cut, 55 percent of all shareholders took the cash option. Compounded, this added to £39 million of missed value.
Multiply that across the numbers of scrip issues and the unrealised value adds up real fast. Our analysis estimates that the missed or unrealised value from scrip non-elections is over a billion dollars a year.
With rights offerings, analysts need to decide whether buying additional shares helps maintain or increase the value of their existing holdings. Opting to do nothing may ultimately dilute the value.
Does this raise any issues around fiduciary duty?
It may. If managers are foregoing analysis and elections of these corporate actions, it wouldn’t be a stretch for investors to claim that these decisions are not being done in their best interest. Regulators, especially in the US, have been keeping a close eye on proxy voting and governance in recent months. the second Markets in Financial Instruments Directive (MiFID II) has also pushed managers to disclose their elections on certain events, which opens the door to greater scrutiny from investors.
But that is not to say that managers should be concerned about fiduciary issues. Rather, there is a real opportunity for managers to capture significant value for their clients by making informed elections. Every basis point of outperformance above an index is valuable. Those managers that demonstrate strong governance are going to instil confidence in their investors, giving them an edge as competition for inflows among managers continues to tighten.
Operationally, how can fund managers address these challenges?
It is important to recognise what’s at stake. It is also good to understand how strained corporate actions analysts are, even as the market continues its recovery. When dividends were cut, many of these notices weren’t shared in a way that would be easily picked up by corporate actions processing platform. Per media reports, some companies notified shareholders via memos announcing the cancellation of annual general meetings. This would require analysts to track down and verify the information.
Analysing the value inherent in voluntary corporate actions is something that processing platforms don’t do. They’re primed to automatically capture and track standard corporate actions and drive the appropriate workflows, but this doesn’t extend to those where an election must be made.
That said, there are complimentary solutions which do the analysis and recommend the favourable course of action. The process of examining and electing a voluntary corporate action can be mostly automated. Internal controls are relatively simple to put in place.
Adding these capabilities to existing corporate actions processing workflows can have the dual upside of maximising the value captured through optimal elections and reducing the burden placed on analysts. This helps ensures that resources aren’t redirected away from other revenue-generating activities.
What do think it will take for managers to grasp the opportunities?
It is about understanding what’s being left on the table – and how simple it can actually be to maximise decision making around voluntary corporate actions. Adding 30 or 50 basis points to annual performance can be as easy as playing a more active role in analysing the value of these events. In a highly competitive marketplace, the potential basis point gains are very meaningful.
On the other side of the coin, no manager wants to be in a position where investors are scrutinizing their governance.
There will need to be a shift in mindsets. Rather than seeing processes like these solely as operational considerations, managers should be exploring how they can actively add to their bottom line.
