We all know index funds and passive investing is taking more and more money from investors. There are very good reasons why that is happening – if you invest over the long term, all indexes remove badly performing companies and replace them with better performing companies. If all the companies are winners, over the long term the index will trend upwards. If you have a reasonable long term time line to invest, ensure your portfolio includes index funds.
The other side of investors is companies, who now have strategies to be included in the index funds. In an article by David Milstead of the Globe and Mail, he outlines the strategies of the company which was known as Encana. The company is in the oil and gas business and recently relocated its head office from Calgary to Denver. It addition, the name has changed to Ovintiv.
The issue with Encana is as a Canadian company it was in the S&P/TSX Composite Index and S&P/TSX 60 which held between 90 million and 120 million shares of the 1.3 billion outstanding or about 10% of the shares were in passive investments. Other analysts put the number closer to 20%.
The problem is the new company Ovintiv will be included in the S&P Mid Cap 400 and the Russell 1000 Indexes which will account for 90% of the above, it does not occur overnight. There will be a lag time between leaving the Canadian index to joining the US Index. The lag time is the Indexes will rebalance in March.
Encana had a market capitalization of $5 billion, but is too small to be in the S&P 500 which requires a market capitalization of $8.2 billion. (At the moment there are shares worth $3.4 trillion tied to the S&P 500).
Over the next few months, one of the analysts who flows the company expects the indexes will have increased the ownership of the stock from 15% to 25%
Linking to dividend paying companies, if you buy larger companies who easily fit into the indexes you do not have to worry about whether the passive indexes will sell or not, but if the company gets into trouble and can not pay its dividend, the market pressures from the indexes will push the stock down further. If the company flirts with the low end of the $8.2 billion in market capitalization, it is better to find an alternative. In the era of indexes, if the company is to be moved out of the index, do not fight the index.
There are more questions than answers, till the next time – to raising questions.