Targeting the Smaller Fish in the Sea: How to Make It Worth Your While

May 11, 2021

In our latest research, Clermont Partners confirmed a sneaking suspicion: a significant portion of the largest institutional investors considered to be actively-managed are, in reality, effectively indexed to the S&P 500. That means that your efforts to target these investors in hopes of securing an outsized position in your stock could be (at least partially) in vain. Even though some of these institutions might hold the largest positions in your stock, their stance on engaging with management is most likely passive.  

While this fact might be intuitive for most IR teams, small- and mid-cap U.S. investors are much more likely to practice active stock picking. Through our research, we identified a set of investors with portfolios comprised of an outsized proportion of small- and mid-cap stocks. We found that for this subset, the correlation to the S&P 500 index is either insignificant or, in some cases, non-existent. What’s more, our follow-up analysis shows that these investors are very good at what they do: they generated greater returns last year compared to their passive and large-cap counterparts. Specifically, in 2020, SMID investors generated average portfolio returns of 34%* compared to 31.5% for large-cap investors and 15.5% for indexed investors.

So, if the goal of your investor meetings is to influence position size, then meeting with smaller investors who are more likely to engage with your narrative, and ultimately take action based upon it, may be your best bet.

But is the juice really worth the squeeze?

Some IR teams wonder about the quality and capacity of smaller investors, especially the lesser-known names, for a couple of reasons. First, in many cases, these investors are smaller in terms of investible assets, which means there is less money in the pot.  Second, there are a lot of them, and the available asset pool is further diluted across many potential investors. Indeed, in our initial analysis of 150 institutions, SMID investors account for 26% of the firms, but only 5% of the collective investable assets. That said, there are many more quality SMID-focused institutions that sit outside of the top 150. Finally, as evidenced by their comparably higher rate of return, these investors may be much choosier about where they put their money and diligent about finding the right fit, making them somewhat of a harder sell.

The bottom line is, it can be a numbers game to get management in front of the right SMID-cap investors, and CFO time does not come cheap. Still, that time can be very well spent for these three key reasons:

  1. There is a greater chance of meaningful engagement. Often, larger institutional investors take meetings for the purpose of risk management. They may even take them solely as a way to gain competitive intelligence with no intention at all of taking any position in the stock. Since meetings with smaller firms are generally more productive, the return is greater even though the upfront investment is greater, too.
  2. There is a greater likelihood of a SMID-cap investor taking an outsized position (relative to market cap). And, for small and medium companies, a $5 million investment from a SMID-cap firm, for example, is still meaningful. It will be more meaningful to the investor, as well.
  3. Compared to one large-cap investment, multiple smaller positions from SMID-cap investors increases shareholder diversity and stabilizes your investor base, making it a sounder overall strategy.

The key lies in doing your homework well.

Clearly, targeting smaller investors can and does make sense for a lot of businesses. But before you begin filling your executives’ calendars with meetings, remember that the engagements will only be productive if you have done your upfront work to ensure good matches.

Here are a few tips that can help:

  • Play the whole field. There are many high-quality SMID-cap investors out there. This is a good thing, but it can also make it more challenging to hone in on the right investors for your business. A sell-side analyst can help by introducing you to the investors it represents, but this list will obviously be limited to their own clients. Find a broader universe of potential SMID-cap shareholders best suited to your investment thesis, and get help from a consultant as it can be time consuming work.
  • Find the right contact. The good news is, once you identify the right SMID-cap investment firms, it is relatively easy to find the right contacts, even if the institution has sub funds. This is simply because there are fewer fund managers to consider. Additionally, the managers tend to be industry agnostic. So, if your narrative is fundamentally appealing, it does not matter if you make widgets or sell software – the fund manager will still talk to you.
  • Thoroughly understand each investor’s approach. Approaches can vary widely across the sea of potential SMID-cap investors. It is mission critical to understand a targeted investor’s philosophy and investment criteria in order to determine if your company is truly a good fit. This is where a good consultant becomes invaluable. Ideally, your consultant will have the analytic and research capabilities to expedite the filtering process and quickly find those investors most receptive to your narrative.
  • Make the first move. Large institutional investors often want to conduct their own thorough analysis on you before they take a meeting. This is not always the case with smaller investors, who have fewer internal resources available to do this work. Many times, SMID-cap fund managers will appreciate the fact that you (or your consultant) have already done the initial due diligence work. Your proactive outreach can go a long way in moving the needle. Keep in mind, however, that limited internal research capabilities also means that these investors might take longer to conduct their own follow-on due diligence before considering an investment. This makes it critical to ensure easy access to your investor presentation and maintain some level of sell-side coverage.
  • Tell a legitimately compelling story. In other words, do not force the match with nice language. Ensure that your messaging is not overly skewed to what the investor will want to hear. Instead, keep it fully aligned with the fundamental characteristics of your company and stock. Just saying you are a growth story does not make you one. Successful SMID-cap investors will quickly see through any fluff.

Above all else, keep it real.

As our research illustrates, targeting active small- and mid-cap investors can set the stage for some of the most productive investor engagement work your company will do. But this strategy in no way represents easy money. The stock pickers may be more likely to give you their time and attention, but for time to be well spent for both your executives and the fund managers, it is on you to do the legwork and ensure your messaging is a good match. When you are realistic about fit, the effort required, and the size of the investment you stand to gain from each investor, you will be satisfied with the results and will be well-positioned for positive investor relations for the long term.

If you need help targeting the right investors or recalibrating your message to appeal to the right investors, contact us.

*10% trimmed mean to eliminate outliers

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