Tag Archives: s&p 500

Future of Securities Class Actions

Securities litigation has a culture defined by multiple elements: the types of cases filed, the plaintiffs’ lawyers who file them, the defense counsel who defend them, the characteristics of the insurance that covers them, the way insurance representatives approach coverage, the government’s investigative policies – and, of course, the attitude of public companies and their directors and officers toward disclosure and governance.

This culture has been largely stable over the nearly 20 years I’ve defended securities litigation matters full time. The array of private securities litigation matters (in the way I define securities litigation) remains the same – in order of virulence: securities class actions, shareholder derivative litigation matters (derivative actions, board demands and books-and-records inspections) and shareholder challenges to mergers. The world of disclosure-related SEC enforcement and internal corporate investigations is basically unchanged, as well. And the art of managing a disclosure crisis, involving the convergence of shareholder litigation, SEC enforcement and an internal investigation involves the same basic skills and instincts.

But I’ve noted significant changes to other characteristics of securities-litigation culture recently, which portend a paradigm shift. Over the past few years, smaller plaintiffs’ firms have initiated more securities class actions on behalf of individual, retail investors, largely against smaller companies that have suffered what I call “lawsuit blueprint” problems such as auditor resignations and short-seller reports. This trend – which has now become ingrained into the securities-litigation culture – will significantly influence the way securities cases are defended and by whom, and change the way that D&O insurance coverage and claims need to be handled.

Changes in the Plaintiffs’ Bar

Discussion of the history of securities plaintiffs’ counsel usually focuses on the impact of the departures of former giants Bill Lerach and Mel Weiss. But although the two of them did indeed cut a wide swath, the plaintiffs’ bar survived their departures just fine. Lerach’s former firm is thriving, and there are strong leaders there and at other prominent plaintiffs’ firms.

The more fundamental shifts in the plaintiffs’ bar concern changes to filing trends. Securities class action filings are down significantly over the past several years, but, as I have written, I’m confident they will remain the mainstay of securities litigation and won’t be replaced by merger cases or derivative actions. There is a large group of plaintiffs’ lawyers who specialize in securities class actions, and there are plenty of stock drops that give them good opportunities to file cases. Securities class action filings tend to come in waves, both in the number of cases and type. Filings have been down over the last several years for multiple reasons, including the lack of plaintiff-firm resources to file new cases as they continue to litigate stubborn and labor-intensive credit-crisis cases, the rising stock market and the lack of significant financial restatements.

Although I don’t think the downturn in filings is, in and of itself, very meaningful, it has created the opportunity for smaller plaintiffs’ firms to file more securities class actions. The Reform Act’s lead plaintiff process gives plaintiffs’ firms incentives to recruit institutional investors to serve as plaintiffs. For the most part, institutional investors, whether smaller unions or large funds, have retained the more prominent plaintiffs’ firms, and smaller plaintiffs’ firms have been left with individual investor clients who usually can’t beat out institutions for the lead-plaintiff role. At the same time, securities class action economics tightened in all but the largest cases. Dismissal rates under the Reform Act are pretty high, and defeating a motion to dismiss often requires significant investigative costs and intensive legal work. And the median settlement amount of cases that survive dismissal motions is fairly low. These dynamics placed a premium on experience, efficiency and scale. Larger firms filed most of the cases, and smaller plaintiffs’ firms were unable to compete effectively for the lead plaintiff role or make much money on their litigation investments.

This started to change with the wave of cases against Chinese issuers in 2010. Smaller plaintiffs’ firms initiated most of them, as the larger firms were swamped with credit-crisis cases and likely were deterred by the relatively small damages, potentially high discovery costs and uncertain insurance and company financial resources. Moreover, these cases fit smaller firms’ capabilities well; nearly all of the cases had “lawsuit blueprints” such as auditor resignations or short-seller reports, thereby reducing the smaller firms’ investigative costs and increasing their likelihood of surviving a motion to dismiss. The dismissal rate has indeed been low, and limited insurance and company resources have prompted early settlements in amounts that, while on the low side, appear to have yielded good outcomes for the smaller plaintiffs’ firms.

The smaller plaintiffs’ firms thus built up a head of steam that has kept them going, even after the wave of China cases subsided. For the last year or two, following almost every “lawsuit blueprint” announcement, a smaller firm has launched an “investigation” of the company, and smaller firms have initiated an increasing number of cases. Like the China cases, these tend to be against smaller companies. Thus, smaller plaintiffs’ firms have discovered a class of cases – cases against smaller companies that have suffered well-publicized problems that reduce the plaintiffs’ firms’ investigative costs – for which they can win the lead plaintiff role and that they can prosecute at a sufficient profit margin.

To be sure, the larger firms still mostly can and will beat out the smaller firms for the cases they want. But it increasingly seems clear that the larger firms don’t want to take the lead in initiating many of the cases against smaller companies and are content to focus on larger cases on behalf of their institutional investor clients.

These dynamics are confirmed by recent securities litigation filing statistics. Cornerstone Research’s “Securities Class Action Filings: 2014 Year in Review” concludes that (1) aggregate market capitalization loss of sued companies was at its lowest level since 1997 and (2) the percentage of S&P 500 companies sued in securities class actions “was the lowest on record.” Cornerstone’s “Securities Class Action Filings: 2015 Midyear Assessment” reports that two key measures of the size of cases filed in the first half of 2015 were 43% and 65% lower than the 1997-2014 semiannual historical averages. NERA Economic Consulting’s “Recent Trends in Securities Class Action Litigation: 2014 Full-Year Review” reports that 2013 and 2014 “aggregate investor losses” were far lower than in any of the prior eight years. And PricewaterhouseCoopers’ “Coming into Focus: 2014 Securities Litigation Study” reflects that, in 2013 and 2014, two-thirds of securities class actions were against small-cap companies (market capitalization less than $2 billion) and that one-quarter were against micro-cap companies (market capitalization less than $300 million). These numbers confirm the trend toward filing smaller cases against smaller companies, so that now, most securities class actions are relatively small cases.

Consequences for Securities Litigation Defense

Securities litigation defense must adjust to this change. Smaller securities class actions are still important and labor-intensive matters – a “small” securities class action is still a big deal for a small company and the individuals accused of fraud, and the number of hours of legal work to defend a small case is still significant. This is especially so for the “lawsuit blueprint” cases, which typically involve a difficult set of facts.

Yet most securities defense practices are in firms with high billing rates and high associate-to-partner ratios, which make it uneconomical for them to defend smaller litigation matters. It obviously makes no sense for a firm to charge $6 million to defend a case that can settle for $6 million. It is even worse for that same firm to attempt to defend the case for $3 million instead of $6 million by cutting corners – whether by under-staffing, over-delegation to junior lawyers or avoiding important tasks. It is worse still for a firm to charge $2 million through the motion to dismiss briefing and then, if it loses, to settle for more than $6 million just because it can’t defend the case economically past that point. And it is a strategic and ethical minefield for a firm to charge $6 million and then settle for a larger amount than necessary so that the fees appear to be in line with the size of the case.

Nor is the answer to hire general commercial litigators at lower rates. Securities class actions are specialized matters that demand expertise, consisting not just of knowledge of the law but of relationships with plaintiffs’ counsel, defense counsel, economists, mediators and D&O brokers and insurers.

Rather, what is necessary is genuine reform of the economics of securities litigation defense through the creation of a class of experienced securities litigators who charge lower rates and exhibit tighter economic control. Undoubtedly, that will be difficult to achieve for most securities defense lawyers, who practice at firms with supercharged economics. The lawyers who wish to remain securities litigation specialists will thus face a choice:

  1. Accept that the volume of their case load will be reduced, as they forego smaller matters and focus on the largest matters (which Biglaw firms are uniquely situated to handle well, on the whole);
  2. Rein in the economics of their practices, by lowering billing rates of all lawyers on securities litigation matters, and by reducing staffing and associate-to-partner ratios; or
  3. Move their practices to smaller, regional defense firms that naturally have more reasonable economics.

I’ve taken the third path, and I hope that a number of other securities litigation defense lawyers will also make that shift toward regional defense firms. A regional practice can handle cases around the country, because litigation matters can be effectively and efficiently handled by a firm based outside of the forum city. And they can be handled especially efficiently by regional firms outside of larger cities, which can offer a better quality of life for their associates and a more reasonable economic model for their clients.

Consequences for D&O Insurance

D&O insurance needs to change, as well. For public companies, D&O insurance is indemnity insurance, and the insurer doesn’t have the duty or right to defend the litigation. The insured selects counsel, and the insurer has a right to consent to the insured’s selection, but such consent can’t be unreasonably withheld. D&O insurers are in a bad spot in a great many cases. Because most experienced securities defense lawyers are from expensive firms, most insureds select an expensive firm. But in many cases that spells a highly uneconomical or prejudicial result, through higher than necessary defense costs or an early settlement that doesn’t reflect the merits but that is necessary to avoid using most or all of the policy limits on defense costs.

Given the economics, it certainly seems reasonable for an insurer to at least require an insured to look at less expensive (but just as experienced) defense counsel before consenting to the choice of counsel – if not outright withholding consent to a choice that does not make economic sense for a particular case. If that isn’t practical from an insurance law or commercial standpoint, insurers may well need to look at enhancing their contractual right to refuse consent or even to offer a set of experienced but lower-cost securities defense practices in exchange for a lower premium. It is my strong belief that a great many public company CFOs would choose a lower D&O insurance premium over an unfettered right to choose their own defense lawyers.

Because I’m not a D&O insurance lawyer, I obviously can’t say what is right for D&O insurers from a commercial or legal perspective. But it seems obvious to me that the economics of securities litigation must change, both in terms of defense costs and defense-counsel selection, to avoid increasingly irrational economic results.

Are We Entering a Bear Market?

We promise, when we wrote our monthly discussion a few weeks back titled, “At the Margin,” we had absolutely no magical insight into the price correction U.S. stocks experienced last week and this, one of the more noticeable in quite some time. You may remember our early August discussion heavily detailed the frailties of human decision-making regarding investments, with particular light being cast on emotional crowd behavior. Greed and fear are two of the most emotionally dominant drivers of decision-making, and two of the greatest enemies of investors. We’ve learned after decades of experience in the financial markets that controlling our emotions is the most important personal exercise for investment decision-making. Having said this, we thought it was important to look at the bigger picture in light of the downward movement in the U.S. and global stock markets over the last several trading days.

Although it’s never fun to experience a price correction, we need to remember that price corrections are normal in financial markets. What is abnormal are markets that go straight up without corrections — or markets that go straight down, for that matter. With all major U.S. equity markets off 10% or more as of this writing, one of the longest periods in market history without a 10% correction has ended. The last time we experienced one was in 2011. The steep correction that has taken place in the last week in U.S. equity markets appears to be a combination of emotional selling and forced selling because of margin calls, as the fundamentals of the markets have not drastically changed in the past week.

Let’s step back for a second.

Is this the beginning of a bear market in US stocks? No one knows. For now, there is not enough “weight of the evidence” to suggest this, but we’re keeping score. Although few probably realize this, about a month ago 20% of the S&P 500 stocks had already fallen 20% from their highs, well before the recent correction in the major indexes. The fact is that a “stealth correction” has already been occurring for some time now. If you own the stocks that have corrected in this manner, you are fully aware. What happened in recent days is that a lot of the “winners” of this year sold off. Historically, market corrections have been nearer an end than a beginning once the leaders finally correct. We will be watching market character closely in the weeks ahead.

It has been so long since we have experienced any type of even semi-meaningful correction in the U.S. equity markets that we have been convinced, when it finally arrived, it would feel like a bear market and emotions would be highly charged. Sound familiar?

Is there plenty to worry about in financial markets and global economies today? You had better believe it, but there has been plenty to worry about for years now in the aftermath of the Great Recession. U.S. corporations and households are a lot healthier today than was the case a number of years ago. Perhaps ironically, it’s the government sector where we find balance sheets impaired. It’s a good thing we can’t buy share ownership in global governments.

The worries will never stop; there is always something to worry about with the flood of data tied to financial markets and global economies. The key is assessing the magnitude of the reality of these worry points and how they may affect real world economic outcomes.

For now, no one knows where the markets will travel with any day-to-day precision. We have been expecting a correction for some time now, although having it happen in just a few days feels like quite the dramatic event. That sense of “free falling” over a short time is never comfortable. We instinctively act to stop the feeling by any means possible; it’s just who we are.

We believe it is imperative to do two things as we move ahead – 1) keep our emotions in check while thinking objectively and 2) assess forward market character on a continuing and intensive basis. As we have stated many a time in our communications to you, risk management is the key to successful investment outcomes over time. We know emotions have recently run higher than has been the case for some time now, and because of this it feels the risks of being invested in the equity markets are greater. If the weight of the evidence tells us this for-now-short-term correction is to become something much deeper, we will not hesitate to take protective action. The key in investing is not pinpointing the market peak prior to a correction nor nailing an exact interim market bottom before a rally. The key is avoiding large bear market drawdowns and participating in favorable market environments to the greatest extent possible.

Stocks: The Many Faces of Volatility

The current year has been characterized by increasing daily volatility in financial asset prices. This is occurring in bonds as well as stocks. In fact, through the first six months of this year, the major equity markets have been trading within a narrow price band, back and forth, back and forth. Enough to induce seasickness among the investment community.

The S&P 500 ended 2014 at 2058. On June 30, 2015, the S&P closed at 2063. In other words, the S&P spent six months going up all of five points, or 0.2%. Yet if we look at the daily change in the S&P price, the S&P actually traveled 1,544 points, daily closing price to daily closing price, in the first six months of the year. Dramamine, anyone?

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Price volatility seems to have increased, but point-to-point percentage price moves have actually been very small. When looked at within the context of an entire bull market cycle, a 3.5% price move in either direction is close to a rounding error. This is the face of volatility we have experienced over the first half of 2015. Not quite as scary as is portrayed in the media, right?

In one sense, what we have really experienced this year is what is termed a “sideways correction.”

Financial markets can correct in any number of ways. We usually think of a correction in prices as a meaningful drop. That is certainly one form of a correction, and never much fun. Markets can also correct in sideways fashion. In a sideways correction, the markets go back and forth, often waiting for fundamentals of the economy and corporate earnings to catch up with prices that have already moved. The markets are digesting prior gains. Time for a “time out.”

At least so far, this is what appears to be occurring this year. Make no mistake about it, sideways corrections heighten the perception of price volatility. That’s why it is so important to step away from the day to day and look at longer-term market character. A key danger for investors is allowing day-to-day price volatility to influence emotions, and heightened emotions to influence investment decision making.

Two issues we do believe to be very important at this stage of the market cycle are safety and liquidity. We live in a world where central banks are openly debasing their currencies, where government balance sheets are deteriorating, where governments (to greater or lesser degrees) are increasing the hunt for taxes and where cash left in certain banking systems is being charged a fee (negative interest rates) just to sit. None of these actions is friendly to capital, which is why we see so much global capital on the move.

It’s simply seeking safety and liquidity. Is that too much to ask?

To understand where the money may go, it’s important to look at the size and character of major global asset classes. In the chart below, we look at real estate and bond (credit) and stock markets. We’ve additionally shown the global money supply and gold.

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One of the key takeaways from this data is that the global credit/bond market is about 2.5 times as large as the global equity market. We have expressed our longer-term concern over bonds, especially government bonds. After 35 years of a bull market in bonds, will we have another 35 years of such good fortune? Not a chance. With interest rates at generational lows, the 35-year bond bull market isn’t in the final innings; it’s already in extra innings, thanks to the money printing antics of global central banks. So as we think ahead, we need to contemplate a very important question. What happens to this $160 trillion-plus investment in the global bond market when the 35-year bond bull market breathes its last and the downside begins?

One answer is that some of this capital will go to what is termed “money heaven.” It will never be seen again; it will simply be lost. Another possible outcome is that the money reallocates to an alternative asset class. Could 5% of the total bond market move to gold? Probably not, as this is a sum larger than total global gold holdings. Will it move to real estate? Potentially, but real estate is already the largest asset class in nominal dollar size globally. Could it reallocate to stocks? This is another potential outcome. Think about pension funds that are not only underfunded but have specific rate-of-return mandates. Can they stand there and watch their bond holdings decline? Never. They will be forced to sell bonds and reallocate the proceeds. The question is where. Other large institutional investors face the same issue. Equities may be a key repository in a world where global capital is seeking safety and liquidity. Again, only a potential outcome.

We simply need to watch the movement of global capital and how that is expressed in the forward price of these key global asset classes. Watching where the S&P ultimately moves out of this currently tight trading range seen this year will be very important. It will be a signal as to where global capital is moving at the margin among the major global assets classes.

Checking our emotions at the door is essential. Not getting caught up or emotionally influenced in the up and down of day-to-day price movement is essential. Putting price volatility and market movement into much broader perspective allows us to step back and see the larger global picture of capital movement.

These are the important issues, not where the S&P closes tomorrow, or the next day. Or, for that matter, the day after that.

Bonds Away: Market Faces Major Shift

As we are sure you are aware, the financial markets have had a bit of a tough time going anywhere this year. The S&P 500 has been caught in a 6% trading band all year, capped on the upside by a 3% gain and on the downside by a 3% loss. It has been a back-and-forth flurry. We’ve seen a bit of the same in the bond market. After rising 3.5% in the first month of the year, the 10-year Treasury bond has given away its entire year-to-date gain and then some as of mid-June. 2015 stands in relative contrast to largely upward stock and bond market movement over the past three years. What’s different this year, and what are the risks to investment outcomes ahead?

As we have discussed in recent notes, the probabilities are very high that the U.S. Federal Reserve will raise interest rates this year. We have suggested that the markets are attempting to “price in” the first interest rate increase in close to a decade. We believe this is part of the story in why markets have acted as they have in 2015.

But there is a much larger longer-term issue facing investors lurking well beyond the short-term Fed interest rate increase to come. Bond yields (interest rates) rest at generational lows and prices at generational highs — levels never seen before by today’s investors. Let’s set the stage a bit, because the origins of this secular issue reach back more than three decades.

It may seem hard to remember, but in September 981, the yield on the 10-year U.S. Treasury bond hit a monthly peak of 15.32%. At the time, Fed Chairman Paul Volcker was conquering long-simmering inflationary pressures in the U.S. economy by raising interest rates to levels no one had ever seen. Thirty-one years later, in July 2012, that same yield on 10-year Treasury bonds stood at 1.53%, a 90% decline in coupon yield, as Fed Chairman Bernanke was attempting to slay the perception of deflation with the lowest level of interest rates investors had ever experienced. This 1981-present period encompasses one of the greatest bond bull markets in U.S. history, and certainly over our lifetimes. Prices of existing bonds rise when interest rates fall, and vice versa. So from 1981 through the present, bond investors have been rewarded with coupon yield (continuing cash flow) and rising prices (price appreciation via continually lower interest rates). Remember, this is what has already happened.

As always, what is important to investors is not what happened yesterday, but rather what they believe will happen tomorrow. And although this is not about to occur instantaneously, the longer-term direction of interest rates globally has only one road to travel – up. The key questions ultimately being, how fast and how high?

This is important for a number of reasons. First, for decades bond investments have been a “safe haven” destination for investors during periods of equity market and general economic turmoil. That may no longer be the case as we look ahead. In fact, with interest rates at generational lows and prices at all-time highs, forward bond market price risk has never been higher. An asset class that has always been considered safe is no longer, regardless of what happens to stock prices.

We need to remember that so much of what has occurred in the current market cycle has been built on “confidence” in central bankers globally. Central bankers control very short-term interest rates (think money market fund rates). Yes, quantitative easing allowed these central banks to print money and buy longer-maturity bonds, influencing longer-term yields for a time. That’s over for now in the U.S., although it is still occurring in Japan and Europe. So it is very important to note that, over the last five months, we have witnessed the 10-year U.S. Treasury yields move from 1.67% to close to 2.4%, and the Fed has not lifted a finger. In Germany, the yield on a 10-year German Government Bund was roughly .05% a month ago. As of this writing, it has risen to 1%. That’s a 20-fold increase in the 10-year interest rate inside of a month’s time.

For a global market that has risen at least in part on the back of confidence in central bankers, this type of volatility we have seen in longer-term global bond yields as of late implies investors may be concerned central bankers are starting to “lose control” of their respective bond markets. Put another way? Investors may be starting to lose confidence in central bank policies being supportive of bond investments — not a positive in a cycle where this buildup of confidence has been such a meaningful support to financial asset prices.

You may remember that what caused then-Fed Chairman Paul Volcker to drive interest rates up in the late 1970s was embedded inflationary expectations on the part of investors and the public at large. Volcker needed to break that inflationary mindset. Once inflationary expectations take hold in any system, they are very hard to reverse. A huge advantage for central bankers being able to “print money” in very large magnitude in the current cycle has been that inflationary expectations have remained subdued. In fact, consumer price indexes (CPI) as measured by government statistics have been very low in recent years.

When central bankers started to print money, many were worried this currency debasement would lead to rampant inflation. Again, that has not happened. We have studied historical inflationary cycles and have not been surprised at outcomes in the current cycle in the least. For the heightened levels of inflation to sustainably take hold, wage inflation must be present. Of course, in the current cycle, continued labor market pressures have resulted in the lowest wage growth of any cycle in recent memory. But is this about to change at the margin? The chart below shows us wage growth may be on the cusp of rising to levels we have not yet seen in the current cycle on the upside. Good for the economy, but not so good for keeping inflationary pressures as subdued as has been the case since 2009.

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You may be old enough to remember that bond investments suffered meaningfully in the late 1970s as inflationary pressures rose unabated. We are not expecting a replay of that environment, but the potential for rising inflationary expectations in a generational low-interest-rate environment is not a positive for what many consider “safe” bond investments. Quite the opposite.

As we have discussed previously, total debt outstanding globally has grown very meaningfully since 2009. In this cycle, it is the governments that have been the credit expansion provocateurs via the issuance of bonds. In the U.S. alone, government debt has more than doubled from $8 trillion to more than $18.5 trillion since 2009. We have seen like circumstances in Japan, China and part of Europe. Globally, government debt has grown close to $40 trillion since 2009. It is investors and in part central banks that have purchased these bonds. What has allowed this to occur without consequence so far has been the fact that central banks have held interest rates at artificially low levels.

Although debt levels have surged, interest cost in 2014 was not much higher than we saw in 2007, 2008 and 2011. Of course, this was accomplished by the U.S. Fed dropping interest rates to zero. The U.S. has been able to issue one-year Treasury bonds at a cost of 0.1% for a number of years. 0% interest rates in many global markets have allowed governments to borrow more both to pay off old loans and finance continued expanding deficits. In late 2007, the yield on 10-year U.S. Treasuries was 4-5%. In mid-2012, it briefly dropped below 1.5%.

So here is the issue to be faced in the U.S., and we can assure you that conceptually identical circumstances exist in Japan, China and Europe. At the moment, the total cost of U.S. Government debt outstanding is approximately 2.2%. This number comes directly from the U.S. Treasury website and is documented monthly. At that level of debt cost, the U.S. paid approximately $500 billion in interest last year. In a rising-interest-rate environment, this number goes up. At just 4%, our interest costs alone would approach $1 trillion — at 6%, probably $1.4 trillion in interest-only costs. It’s no wonder the Fed has been so reluctant to raise rates. Conceptually, as interest rates move higher, government balance sheets globally will deteriorate in quality (higher interest costs). Bond investors need to be fully aware of and monitoring this set of circumstances. Remember, we have not even discussed the enormity of off-balance-sheet government liabilities/commitments such as Social Security costs and exponential Medicare funding to come. Again, governments globally face very similar debt and social cost spirals. The “quality” of their balance sheets will be tested somewhere ahead.

Our final issue of current consideration for bond investors is one of global investment concentration risk. Just what has happened to all of the debt issued by governments and corporations (using the proceeds to repurchase stock) in the current cycle? It has ended up in bond investment pools. It has been purchased by investment funds, pension funds, the retail public, etc. Don Coxe of Coxe Advisors (long-tenured on Wall Street and an analyst we respect) recently reported that 70% of total bonds outstanding on planet Earth are held by 20 investment companies. Think the very large bond houses like PIMCO, Blackrock, etc. These pools are incredibly large in terms of dollar magnitude. You can see the punchline coming, can’t you?

If these large pools ever needed to (or were instructed to by their investors) sell to preserve capital, sell to whom becomes the question? These are behemoth holders that need a behemoth buyer. And as is typical of human behavior, it’s a very high probability a number of these funds would be looking to sell or lighten up at exactly the same time. Wall Street runs in herds. The massive concentration risk in global bond holdings is a key watch point for bond investors that we believe is underappreciated.

Is the world coming to an end for bond investors? Not at all. What is most important is to understand that, in the current market cycle, bonds are not the safe haven investments they have traditionally been in cycles of the last three-plus decades. Quite the opposite. Investment risk in current bond investments is real and must be managed. Most investors in today’s market have no experience in managing through a bond bear market. That will change before the current cycle has ended. As always, having a plan of action for anticipated market outcomes (whether they ever materialize) is the key to overall investment risk management.

2015 ROI Survey on Customer Experience

Six years ago, we launched the Customer Experience ROI Study in response to a sad but true reality: Many business leaders pay lip service to the concept of customer experience – publicly affirming its importance, but privately skeptical of its value.

We wondered… how could one illustrate the influence of a great customer experience, in a language that every business leader could understand and appreciate?

And so the Customer Experience ROI Study was born, depicting the impact of good and bad customer experiences, using the universal business “language” of stock market value.

It’s become one of the most widely cited analyses of its kind and has proven to be an effective tool for opening people’s eyes to the competitive advantage accorded by a great customer experience.

This year’s study provides the strongest support yet for why every company – public or private, large or small – should make differentiating their customer experience a top priority.

Thank you for the interest in our study. I wish you the best as you work to turn more of your customers into raving fans.

THE CHALLENGE

What’s a great, differentiated customer experience really worth to a company?

It’s a question that seems to vex lots of executives, many of whom publicly tout their commitment to the customer, but then are reluctant to invest in customer experience improvements.

As a result, companies continue to subject their customers to complicated sales processes, cluttered websites, dizzying 800-line menus, long wait times, incompetent service, unintelligible correspondence and products that are just plain difficult to use.

To help business leaders understand the overarching influence of a great customer experience (as well as a poor one), we sought to elevate the dialogue.

That meant getting executives to focus, at least for a moment, not on the cost/benefit of specific customer experience initiatives but, rather, on the macro impact of an effective customer experience strategy.

We accomplished this by studying the cumulative total stock returns for two model portfolios – composed of the Top 10 (“Leaders”) and Bottom 10 (“Laggards”) publicly traded companies in Forrester Research’s annual Customer Experience Index rankings.

As the following vividly illustrates, the results of our latest analysis (covering eight years of stock performance) are quite compelling:

THE RESULTS

8-Year Stock Performance of Customer Experience Leaders vs. Laggards vs. S&P 500 (2007-2014)

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Comparison is based on performance of equally weighted, annually readjusted stock portfolios of Customer Experience Leaders and Laggards relative to the S&P 500 Index.

Leaders outperformed the broader market, generating a total return that was 35 points higher than the S&P 500 Index.

Laggards trailed far behind, posting a total return that was 45 points lower than that of the broader market.

THE OPPORTUNITY

It’s worth reiterating that this analysis reflects nearly a decade of performance results, spanning an entire economic cycle, from the pre-recession market peak in 2007 to the post-recession recovery that continues today.

It is, quite simply, a striking reminder of how a great customer experience is rewarded over the long term, by customers and investors alike.

The Leaders in this study are enjoying the many benefits accorded by a positive, memorable customer experience:

  • Higher revenues – because of better retention, less price sensitivity, greater wallet share and positive word of mouth.
  •  Lower expenses – because of reduced acquisition costs, fewer complaints and the less intense service requirements of happy, loyal customers.

In contrast, the Laggards’ performance is being weighed down by just the opposite – a poor experience that stokes customer frustration, increases attrition, generates negative word of mouth and drives up operating expenses.

The competitive opportunity implied by this study is compelling, because the reality today is that many sources of competitive differentiation can be fleeting. Product innovations can be mimicked, technology advances can be copied and cost leadership is difficult to achieve let alone sustain.

But a great customer experience, and the internal ecosystem supporting it, can deliver tremendous strategic and economic value to a business, in a way that’s difficult for competitors to replicate.

LEARN FROM THE LEADERS

How do these Customer Experience Leading firms create such positive, memorable impressions on the people they serve? It doesn’t happen by accident. They all embrace some basic tenets when shaping their brand experience – principles that can very likely be applied to your own organization:

  1. They aim for more than customer satisfaction. Satisfied customers defect all the time. And customers who are merely satisfied are far less likely to drive business growth through referrals, repeat purchases and reduced price sensitivity. Maximizing the return on customer experience investments requires shaping interactions that cultivate loyalty, not just satisfaction.
  2. They nail the basics, and then deliver pleasant surprises. To achieve customer experience excellence, these companies execute on the basics exceptionally well, minimizing common customer frustrations and annoyances. They then follow that with a focus on “nice to have” elements and other pleasant surprises that further distinguish the experience.
  3. They understand that great experiences are intentional and emotional. The Leading companies leave nothing to chance. They understand the universe of touchpoints that compose their customer experience, and they manage each of them very intentionally – choreographing the interaction so it not only addresses customers’ rational expectations, but also stirs their emotions in a positive way.
  4. They shape customer impressions through cognitive science. The Leading companies manage both the reality and the perception of their customer experience. They understand how the human mind interprets experiences and forms memories, and they use that knowledge of cognitive science to create more positive and loyalty-enhancing customer impressions.
  5. They recognize the link between the customer and employee experience. Happy, engaged employees help create happy, loyal customers (who, in turn, create more happy, engaged employees!). The value of this virtuous cycle cannot be overstated, and it’s why the most successful companies address both the customer and the employee sides of this equation.

To download a copy of the complete Watermark Consulting 2015 Customer Experience ROI Study, please click here.