Profit from institutional investors’ power

Eddie Cochrane lamented in his 1958 hit ‘Summertime Blues’ that his congressman brushed him off with: “I’d like to help you son, but you’re too young to vote.” At AGMs, age may not matter—but size does. Let big institutional investors be your friends in high places.

In theory, shareholders like you own companies. The presidents, chief executive officers, chief financial officers and other top managers are your employees. But the reality is different.

Institutional investor

Big institutional investors can help swing the power balance between management and shareholders back to the owners’ side of the equation.

Over the years large corporations became owned by thousands of individual shareholders. The majority of these shareholders owned a few hundred or a few thousand shares. This dispersion of shareholder power effectively increased management’s power.

Some managements began to treat shareholders like you shabbily. They often entrenched and richly rewarded themselves—at your expense. And some managers took a cavalier attitude towards your money. They would spend it on company jets, costly offices adorned with pricey paintings and furniture, their favourite charities and other extravaganza.

Schemes to align management’s interests with yours sometimes failed. Often they gave management a short-term focus while losing sight of what would ensure your company’s long-term prosperity. Cutting capital investment, for instance, can temporarily increase a company’s earnings. But it jeopardizes the company’s future. Such short-term jumps in profits and share prices sometimes coincided with the exercising of management’s stock options.

Institutional investors invest trillions

If you didn’t like the arrangement, you could only ‘vote with your feet’ and sell.

Since the 1990s, however, big institutional investors such as mutual funds and pension funds have invested trillions of dollars in stocks. As a result, they’ve gained a lot of power at many companies. This can benefit you since in pursuing their own interests, they also help yours.

For example, institutional shareholders of Key stock Canadian Pacific Railway were dissatisfied with its performance under chief executive officer Fred Green. Meanwhile, rival and Key stock Canadian National Railway was doing much better under its chief executive officer, Hunter Harrison. Mr. Harrison had worked at railroads all his life.

After Mr. Harrison left CN, the institutions wanted him to run CP. While CP’s former management backed Mr. Green, the institutions ignored management and hired Mr. Harrison. We, too, supported Mr. Harrison’s appointment. CP’s fortunes improved sharply.

Keep in mind, too, that institutions can hire Glass Lewis Canada or Institutional Shareholder Services. These firms can provide advice on how to vote.

When management’s mistakes damage a company’s share price, it hurts the returns of the institutions. This could lead to the firing of an institutional manager if the plunging company drags down his or her returns enough. So institutions take a company’s mistakes very seriously.

Voting with their feet is difficult

For many of these institutions, selling is difficult. After all, disposing of their large holdings can cause the shares to plunge. Besides, where are they going to reinvest the diminished proceeds?

To the extent that big institutions demand more of corporate Canada, you’ll profit. The big institutional investors are in effect your powerful friends.

This is an edited version of an article that was originally published for subscribers in the March 29, 2019, issue of The Investment Reporter. You can profit from the award-winning advice subscribers receive regularly in The Investment Reporter.

The Investment Reporter, MPL Communications Inc.
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