The last several weeks have been inarguably the most volatile in U.S. market history. Prior to market open today, March 20th, the S&P 500 has risen or fallen at least 4% in eight straight trading sessions, the longest streak in history. On March 13th, following several days of market declines of 5% or greater, the White House’s announcement of a substantial COVID-19 federal stimulus package incited a massive short squeeze in the last hour of trading, sending the major indices to their greatest single day percentage increase since October 2008. Today, ongoing developments in federal stimulus bills and an increasing COVID-19 infection curve are straddling the market in an immense level of volatility. To call these conditions “unprecedented” would be a gross understatement.

Just as schools, restaurants, and retailers around the U.S. are shuttering down to combat this global pandemic, investors are working to batten down the hatches around their portfolio, scrutinizing companies across market capitalization and industry for their balance sheet health, liquidity, and debt covenants. This shift in focus towards companies’ defensive playbook is changing how investors are evaluating both current positions and new ideas, and is not going away anytime soon.

Over the past 11 years since the last bear market, traditional stock picking has been under siege by the rise in quantitative investing and passive investing, which provide lower-cost options to deliver in-line market performance to institutional investors. The cost-cutting headwinds facing fundamental active investors have also been met by increased pressure to generate alpha, or risk-adjusted returns over a stated portfolio benchmark. Given the increased level of difficulty for active portfolio managers to consistently deliver outperformance, passive investment has seen substantial inflows in recent years and has quickly become the easiest way to earn a return in-line with the broader market. That said, despite current secular headwinds facing active investors today, depressed market valuations driven by near-term COVID-19 fears are opening the door for the traditional stock picker to move back into the fold.

The state of the fundamental active investor today

We recently spoke with a number of long-only buy-siders to get a pulse on how they are managing current holdings and evaluating new positions today, along with how they’re thinking about corporate communication and engagement amid an increasingly murky market environment.

Macroeconomic environment

Views around the long-term severity of the current environment were somewhat mixed among investors we spoke with; however, most believe that a substantial amount of downside movement remains before we find a bottom in the market.

“The current market volatility is unprecedented. We have not found a floor in this market, and it is certainly going to get worse before it gets better.”

– Value-oriented buy-sider

“The severity of this downturn should start to become more clear as we see economic data come in, but in the absence of some of that data today, we’re focused on survival in the short-term for some of the names in our portfolios.”

– Value-oriented buy-sider

“It’s hard to tell what is being priced into the market today. We will have much more clarity once we see how the market responds to increased COVID-19 testing and economic data points.”

– Value-oriented buy-sider

“Once we have a clear sense that coronavirus cases have peaked here in the U.S., investors can start doing the math and buying on the other side of that.”

– Value-oriented buy-sider

“We’re already in a recession today – it’s not going to be a ‘V’ shape recovery, it’s going to be an ‘L.’”

– Value-oriented buy-sider

“It will likely be three to four weeks before U.S. cases of COVID-19 begin cresting.”

– Value-oriented buy-sider

Valuation

In the current period of free-falling stock prices, fundamental investors are focused on quality businesses that are trading at a disconnect from their intrinsic value.

“I am looking at companies from a bottom-up approach, focusing on material impact to their business from COVID-19 today and potential impact over the coming weeks and months ahead, and contrasting that view with how the market is treating the stock. If I believe the stock is not substantially impacted by COVID-19 and is trading at an attractive price because it’s been decimated by the market, I am more likely to view the stock as an opportunity today.”

– Value-oriented buy-sider

“We’re looking at valuation on a case-by case basis – there are definitely some quality companies that have been oversold.”

– Value-oriented buy-sider

“We still have the same level of conviction in names that we had before this pandemic, and with our three- to five-year time horizon, we’re making sure we understand any near-term business risks so we’re able to capitalize on market opportunities.”

– Value-oriented buy-sider

“We’re focused on depressed stocks of high-quality companies with good balance sheets and are buying things selectively small – ten to twenty basis points position levels.”

– Value-oriented buy-sider

“One of our bigger risks is missing opportunities today and getting left behind when this market takes off again.”

– Value-oriented buy-sider

Balance sheet and liquidity

Given the unforeseen future business impact of COVID-19, investors today are focused on balance sheet health now more than ever.

“One thing I need to know – where does your business model, and ultimately solvency, get stressed? For companies with higher leverage, what is the breakeven EBITDA point where your covenants are at risk?

Sharpening my understanding of the magnitude of a slowdown a business can absorb before they are materially impacted is at the top of my list.”

– Value-oriented buy-sider

“Liquidity concerns are top of mind for everybody, and it’s something we’re focusing on with all of our positions. Even companies that are in a net-cash position, we’re still asking them questions to understand their usage of revolvers in funding their business, how they draw down credit, and in what capacity they use credit.”

– Value-oriented buy-sider

“We’re focused on quality names with healthy balance sheets, but also believe there may be some highly levered companies that have the ability to outperform coming out of this downturn, given some of the valuation levels today. We are not ready to start going after those types of names yet, but there could be opportunity there.”

– Value-oriented buy-sider

Communications the Street is Looking for

Overcommunicate, first and foremost: Investors are concerned with understanding both how you’re managing through the known risks facing your business today, and how you’re preparing to handle unknown risks that could be impacting your business tomorrow.

“If companies have meaningful data or information to share related to their near-term business outlook, it’s important they share it with investors. However, I’ve also been on earnings calls recently where the answer to COVID-19-impact questions has been, ‘we just do not know’, and that is OK to communicate too.”

– Value-oriented buy-sider

“Given the level of uncertainty facing companies today, I am less inclined to believe company guidance updates related to COVID-19. We are more concerned with the balance sheet and liquidity – that is where we would prefer additional communication.”

– Growth-oriented buy-sider

“It’s even more important now to be able to access comprehensive information on the investor relations website – overview decks and updated FAQs are extremely helpful in this environment.”

– Value-oriented buy-sider

Insider buying: Highlighting meaningful stock buying activity from your management team and/or Board of Directors sends a strong signal to investors that insiders believe in the long-term outlook of the business.

“One company I own had their stock hit substantially early last week. Later in the week, their CEO, CFO, GC and two Directors all bought a meaningful amount of shares – I was glad to see those Form 4 filings; it’s a great signal for investors.”

– Value-oriented buy-sider

Prepare to play defense: While management teams’ engagement with investors over the last decade has been centered around business growth, top-line expansion, and earnings power, those conversations are quickly changing today. Investors want reassurance that your business does not foresee near-term headwinds to operating as a going concern and want greater disclosure around available levers to pull related to your cost structure, maintenance capital expenditure requirements, and ability to generate positive free cash flow.

“In this environment, we are focused on current portfolio holdings over new ideas and are specifically looking for increased disclosure around the balance sheet and liquidity.”

– Growth-oriented buy-sider

“To the extent that companies can provide clarity around their free cash flow breakeven level in this environment, that is extremely helpful.”

– Value-oriented buy-sider

“Our focus right now is solely around companies’ balance sheet constructs and sustainability of the business – we are not focused on the top-line.”

– Value-oriented buy-sider

“We’re focused on understanding debt covenants, liquidity and cost structure flexibility right now – we aren’t expecting specific details on top-line impact.”

– Value-oriented buy-sider

“To go out and buy stocks today, investors have to think more like lenders with respect to liquidity and balance sheets. Our biggest focus is to make sure companies have enough cash on hand to service debt and make it through the next couple of quarters.”

– Value-oriented buy-sider

“It’s extremely important for companies to figure out how to communicate their debt coverage and debt covenants to investors today.”

– Value-oriented buy-sider

“I need to understand companies’ liquidity positions, and I want to hear how companies are positioned to manage their business through a downturn; in my view, we are already in a recession.”

– Value-oriented buy-sider

Think about going digital: As we continue to see an increasing number of investor conferences and NDRs get canceled, finding alternative channels of communication, with or without the sell-side, is crucial.

“We are starting to plan for more-frequent, shorter duration phone calls, or ‘status checks’ with companies.”

– Value-oriented buy-sider

“I am planning for a lot more phone calls with companies. One conference I was going to attend next week was just canceled, and the conference sponsor is setting up a conference call dial-in that allows investors to keep their entire meeting schedule intact. While clearly not as beneficial as in-person meetings, it’s still incredibly helpful.”

– Value-oriented buy-sider

“We definitely want to increase our contact, especially with some of the companies we own that have been more volatile. It’s helpful to understand where company management teams’ heads are at, and more frequent communication gives us more confidence in our current holdings and top ideas.”

– Value-oriented buy-sider

So, what does this mean for your IR program? Be prepared to evolve it to the “New Normal.” Starting next week, Clermont Partners will begin a series on this topic. Hiding is not the answer in uncertain times, staying ahead of the curve is.