674  Investor Communications Targeting Communications by Segment Which of these investors matter most for the stock price? Analyzing the trad- ing behavior of all four investor groups in more detail, we find support for the idea that intrinsic investors are the ultimate drivers of share prices over the long term. Exhibit 34.3 helps make the case, setting aside the inherently short-term- focused mechanical investors and closet indexers. At face value, traders might seem to be the most likely candidates for influencing share price in the market. They own 35 to 40 percent of the institutional U.S. equity base, and as the first two columns show, they trade much more than intrinsic investors. Their overall transaction volume is made up of many more trades—of which many are trades in the same stock within relatively short time periods. The average trader fund bought and sold over $80 billion worth of shares in 2006, more than 12 times the amount traded by the typical intrinsic investor. Similarly, as shown in the third column, the typical trader also buys or sells around $277 million in each equity stock he or she holds—far more per stock than the average intrinsic investor. But the last column in the exhibit, which shows the value of effective daily trading per investment on the days that an investor traded at all, is the figure that discloses the real impact of each investor group on share prices in the market. Effective daily trading is higher by far among intrinsic investors: when intrinsic investors trade, they buy or sell in much larger quantities than trad- ers do. Although they trade much less frequently than the traders group, they hold much larger percentages of the companies in their portfolios, so when they do trade, they can move the prices of these companies’ shares. Ultimately, therefore, intrinsic investors are the most important investor group for setting prices in the market over the longer term. As a result, companies should focus their investor communications effort on intrinsic investors. If intrinsic investors’ view of the value of your company is consistent with your own view, the market as a whole is likely to value EXHIBIT 34.3  Intrinsic Investors Have Greatest Impact on Share Price 11 3 Trader Intrinsic Per segment, $ trillion Total trading per year Effective trading per day¹ 88 277 72 Per investment,3 $ million 1 7–30 Per investment,3 $ million 6 Per investor,2 $ billion 1 Trading activity in segment per day that trade is made. 2 Per investor in segment. 3 Per investor in segment per investment. Source: R. Palter, W. Rehm, and J. Shih, “Communicating with the Right Investors,” McKinsey on Finance, no. 27 (Spring 2008): 1–5. Which Investors Matter?  675 your company as you do, because of the role intrinsic investors play in driv- ing share prices. Their understanding of long-term value creation also means they’re more likely than other investors to hold on to a stock, supporting the management team through periods of short-term volatility (so long as they believe these periods do not reflect a material change in the underlying value of the company). These are the investors to whom you should listen when you want to understand what the market thinks of your company. A conundrum for companies is how to treat closet indexers, because they may be some of a company’s largest investors. Remember, a closet indexer is likely to have more than 200 different companies in his or her portfolio, and most of this investor’s holdings are in proportion to the company’s size in an index such as the S&P 500. Our first step is to examine whether the closet indexer is significantly over- or underweight in any company or industry. If the answer is yes, we move them to the intrinsic category with respect to that company or industry. If not, we keep the investor categorized with the closet indexers. CEOs and CFOs have substantial demands on their time, and investors worry when they spend too much time with investors instead of running the company. Just as a CEO must decide which customers to spend time with, CEOs and CFOs must proactively decide which investors will get their time. Our investor segmentation makes it clear that CEOs and CFOs should focus their time on a small set of intrinsic investors, and delegate interactions with trading investors and closet indexers to their investor relations executives. In fact, one of the key roles of the investor relations department should be to determine analytically which investors CEOs and CFOs should develop relationships with, facilitate those relationships, and be the gatekeeper who handles low-priority investors on behalf of the CEO or CFO. The gatekeeper role may not be popular with investors, but it’s essential. Of course, CEOs and CFOs can’t ignore the sell-side analysts, whose role has changed over time. Their job is to support their clients, and their most important clients are those who generate the most trading commissions—the trading-oriented investors. Many sophisticated trading (and intrinsic) inves- tors are less concerned about whether the analyst has issued a buy or a hold on a stock (sell recommendations are almost nonexistent), preferring up-to- date news about the company. Hence, sell-side analysts tend to focus on short- term events and near-term earnings so they can be first to pass the news to their clients. This said, there are often one to three sell-side analysts with deep under- standing of the industry dynamics and the company’s strategies, opportuni- ties, and risks. These sell-side analysts resemble intrinsic investors in their approach. The logical way to treat sell-side analysts is to segment them into those whose interests and approach tend to mimic trading investors and those whose approach mimics intrinsic investors, and then to pay more attention to the latter segment.