Risk and uncertainty are important concepts to understanding the purpose and role of Investor Relations. They are central when determining what information to communicate, and consequently important to determining a fair valuation of a company’s securities.
The National Investor Relations Institute, the leading professional organization for Investor Relations practitioners in the US, defines Investor Relations as follows:
Investor relations is a strategic management responsibility that integrates finance, communication, marketing and securities law compliance to enable the most effective two-way communication between a company, the financial community, and other constituencies, which ultimately contributes to a company’s securities achieving fair valuation. (Adopted by the NIRI Board of Directors, March 2003.)
In practice, the role of Investor Relations practitioners is often described as providing company information to the financial community to enable informed investment decisions. Or, the function of providing investors an accurate account of the company’s affairs. All with the goal of contributing to a fair valuation of the company, consistent with the above definition by NIRI.
But what type of information comprises effective two-way communications between a company and the financial community? What is an accurate account of the company’s affairs, what information enables informed decisions? To state the question more specifically: what type of information should Investor Relations communications share and what educational objectives should be served by such communications in order to support a fair valuation of the company?
This is a central question in Investor Relations and a crucial element of effective communications that deserves further thought. So, while the above overview of the Investor Relations function is accurate as far as it goes, it’s an incomplete explanation.
Some clarity on this topic is perhaps best introduced through a quote by Seth Klarman, a well-known U.S. value investor. He stated: “Risk is not inherent in an investment; it is always relative to the price paid. Uncertainty is not the same as risk. Indeed, when great uncertainty — such as in the fall of 2008 — drives securities prices to especially low levels, they often become less risky investments.”
Klarman’s statement incorporates two important points for the Investor Relations practitioner. First, that risk and uncertainty are distinct concepts. Second, neither risk nor uncertainty is inherently good or bad for any particular investment.
Despite Klarman’s statement and the insights it imparts, when it comes to investing in public companies, the words “risk” and “uncertainty” are perhaps not given their due attention as they relate to Investor Relations. In fact, they are sometimes thrown about interchangeably although, as noted, they hold different meanings. It’s important for Investor Relations, and communications with other stakeholders generally, to understand the two concepts.
The word “risk” is generally understood to refer to a quantifiable unpredictable event. It’s an event with measureable probabilities, like throwing a dice. “Uncertainty” is an event that is unpredictable and not quantifiable. As such, it is an event without measurable probability, like an event considered an act of God – such as the 2008 stock market fall noted by Klarman. While risk can be calculated and allowed for, “uncertainty” can only be taken into account, perhaps, by human instinct.
Risk and uncertainty are important concepts to Investor Relations because they are key factors investors consider in understanding the potential profit (or loss) of an investment decision – and even in how to structure an investment. An investor’s superior identification and understanding of a company’s risks and uncertainties, in fact, can differentiate a superior investment decision. Thus, knowing the events with measurable probabilities and the events with unknown probabilities is important. As is an appreciation for the possibility of unknown events with unknown probabilities.
Consequently, neglecting consideration of risk and uncertainty in understanding the purpose and role of Investor Relations is an error. In large part, the role of Investor Relations should be to focus on providing information that clarifies a company’s risk and uncertainty profile while not engaging in communication practices that could adversely alter the risk and uncertainty profile of a company, or perception thereof, to investors.
This is an underlying central understanding to effective Investor Relations communications and in large part should inform what information is important to communicate to the financial community and how that information should be contextualized within communications best practices. Doing so will go a long way towards supporting a fair valuation of a company’s securities.