Encana Corp. expects its decision to move its head office to the United States will give the company membership in U.S. stock market indexes, exposing it to large U.S. index funds. But the move raises questions about which U.S. indexes Encana might join and the extent to which investors will benefit.
Shares in Encana, an oil and gas producer currently based in Calgary, trade on the Toronto Stock Exchange and the New York Stock Exchange. Encana is part of the S&P/TSX 60, the exclusive index of the biggest companies in Canada, and is one of the larger energy companies in the S&P/TSX Composite, the broadest measure of the Canadian markets and one used for many mutual and exchange-traded funds (ETFs). That means investors who own any funds that include stock from companies that are part of the broad index (often referred to as tracking) will have exposure to Encana.
If it gets the shareholder and regulatory approval to move to the United States, it should exit those indexes, and Canadian funds may have to sell their Encana shares.
And it will find itself too small to join the S&P 500, the index that has an estimated US$3.6-trillion, with a 't', worth of ETFs and mutual funds tracking it. It takes a market value of US$8.2-billion to join that club, and Encana shares would have to rise by more than 50 per cent before it would even be considered.
In December, 2017, research for The Globe and Mail, Morningstar Direct found just $125-billion in Canadian mutual funds and exchange-traded funds whose returns were closely correlated with those of the companies in the S&P/TSX Composite, including the one that explicitly say they track that index.
“Inclusion in an index usually means that there is more demand [for a stock], and being removed from an index usually means that there is less,” said Chris Murray, a managing director at AltaCorp Capital Inc., who focuses on changes in index membership.
“It’s too simple to say: U.S. good, Canada bad," he said. "You are perhaps moving from where you are a larger component of a smaller index to a smaller component of a larger index.”
Doug Suttles, chief executive officer of Encana, said in a statement on Thursday that “a domicile in the United States will expose our company to increasingly larger pools of investment in U.S. index funds and passively managed accounts, as well as better align us with our U.S. peers.”
Encana expects that shifting to a U.S. domicile – but maintaining its dual-listing on the TSX and the NYSE – will raise the value of the company because the U.S. equity market is 15 times larger than the Canadian market.
As well, the company noted that U.S. energy peers, including Apache Corp., Marathon Oil Corp. and Devon Energy Corp., benefit from a higher exposure to index investors: Index funds account for an estimated 30 per cent of the U.S. investor base for those U.S. energy stocks, versus just 10 per cent for Encana, according to the company.
Indeed, there is a huge flight to what’s called “passive” investing, or simply following an index. Mark Wiseman, the former CEO of Canada Pension Plan Investment Board who’s now head of Active Equities at asset manager BlackRock Inc., told a Toronto audience on Oct. 24 that major institutional investors are increasingly having difficulty generating market-beating returns by picking stocks, so they’re moving money to index funds or private assets that the ordinary investor can’t access. “This is profound. The world is moving to two ends of the barbell very, very quickly. In liquid markets, it’s moving more and more to index and ETFs. And in [market-beating] strategies, it’s moving more, more to privates.”
Eric Kirzner, professor emeritus of finance at the the University of Toronto’s Rotman School of Management, said that while investors and institutions that track indexes will automatically pick up shares in a company that has joined an index, “Does that mean higher prices? Not necessarily."
And which indexes Encana will join remains to be seen.
Most likely is inclusion in the S&P MidCap 400, where the minimum capitalization is US$2.4-billion, and the MidCap 400 Capped Energy Index, where, according to S&P Global Market Intelligence, it would be the largest company.
FTSE Russell, a subsidiary of the London Stock Exchange, manages the Russell indexes. Its Russell 3000, an index of the 3,000 largest U.S. stocks, is subdivided into the Russell 1000 - the 1,000 biggest companies - and the Russell 2000, the companies ranked 1,001 through 3,000. The Russell 2000 is a popular index often used to invest in smaller-capitalization stocks.
Currently, according to S&P Global Market Intelligence, about 775 companies in the Russell 3000 are larger than Encana, which would put it in the Russell 1000 - and outside the popular small-cap index.
The Vanguard Group Inc. and Fidelity Investments’ FMR LLC are already two of Encana’s five biggest investors, holding a combined 82 million shares, or 6 per cent of Encana, according to S&P Global Market Intelligence. The five top holders of Encana shares are U.S.-based, holding a combined 27 per cent of the company.
The biggest Canadian institutional holder of Encana is Letko, Brosseau & Associates Inc. of Montreal, with just over 36 million shares.
With reports from Clare O’Hara and Andrew Willis.