What is Clientele Effect?

A majority of investors enter the stock market when they are relatively young and have a regular source of income, such as their salaries. They cover the expenses related to daily lives through their salary and look to invest whatever they can save. The savings that they invest are generally used to achieve short-term goals, such as buying a car, a house etc.

However, not all inventors invest in the stock market to achieve short-term financial goals. What if an investor is in his 50s and has achieved all of the short-term goals but wants to build a retirement fund for a time when he will not have a regular source of income? For such inventors, the risk appetite decreases by a huge margin, and they look for less volatile stocks that can provide them with steady returns, if not high capital appreciation.

Companies have various different policies that affect their business model and make them identifiable to the above-mentioned types of investors. For example, blue-chip stocks are less volatile and provide regular dividends to their shareholders. On the other hand, mid-cap companies are more volatile and do not offer the benefit of regular dividends. As all of these factors are the results of company policies, a theory called Clientele Effect comes into play.

But before you understand the clientele effect, let’s understand a basic thing about investors.

Relationship between the shareholders and stock price

If you buy the shares of a company, you become the owner of the company in the proportion of the percentage of bought shares. From the day you buy the shares, you are termed as the shareholder. As a shareholder, you are entitled to receive a portion of the profit of the company. This amount is called the dividend amount, and it is up to the company to declare it as per its financial performance.

However, companies already have policies that are listed in their company laws that allow an investor to know if the company is a dividend-paying company. As these shareholders have voting rights, they can influence the company decisions and, ultimately, company stock. If the shareholders are not happy with any changes to these laws, their demands or opposition can result in price fluctuations. This happens mainly because they end up selling the stock when they know it is not possible anymore to achieve their initial trading goals.

The Clientele Effect?

The clientele effect is defined as the fluctuation in a company’s stock price due to the demands, expectations, and goals of its investors or shareholders. Here, investors can be institutional investors such as mutual fund houses, financial entities etc., and the shareholders are retail investors who have their own personal goals. The investors' demand may come in opposition to the change in policies carried out by the company executives like dividend payout, tax, use of funds or any other policy change that may affect the company stock price.

The central idea behind the clientele effect is that investors are always attracted and invest as per the current company policies, which they expect to be consistent in the coming years. If a company changes its policies, the change is always reflected in the share price of the company stocks. If the changes are negative, the clientele effect suggests that the investors have to adjust their stock holdings according to the policy changes.

How does the Clientele Effect work?

Institutional investors such as big investment houses, mutual funds, along with retail investors, always look to achieve their financial goals, short or long term. As every investment is goal-based, a change in any of the company policies can interrupt the likeliness of the investors achieving those goals. For example, growth stocks are highly volatile and focus more on increasing in price rather than providing a regular dividend amount to their investors. On the other hand, companies that offer a regular dividend amount are not highly volatile and do not appreciate that much in their prices but offer a promise of steady income to low-risk appetite investors.

Let’s say if you have invested in a company’s stock because of its current dividend policy, which binds the company to offer 20% of its profits to be payable as a dividend. As you have invested in other highly volatile growth stocks, your goal with this investment was to ensure a steady income every year. However, the company has changed its policy and to offer only 5% of the profits as dividends moving forward. Since the dividend amount from now on will be considerably low, you would feel there is no point keeping the stock now. As a result, you sell the stock and buy a different stock that offers 20% of profits as a dividend.

Here, if only you sell the shares, the stock price will not fall by a huge margin, but imagine a case where a big mutual fund company decides to sell all of the stock holdings. That’s where the clientele effect takes place and decreases the price of the stock substantially.

Benefits of Clientele Effect

The Clientele Effect is generally deemed negative when it can be immensely positive in its consequences. For example, the company policies will always be negative. A company can change its policies to offer more benefits to the investors. In the above example, it may be that the company alters its policies and chooses to offer 30% profits as dividends from next year. This will increase the positivity factor for the company and may attract more investors to buy the company stock.

Furthermore, the best benefit of the clientele effect is the retention of the current investors. As long as they know that the change in the company policy is positive and will help them achieve their investing goals, they will hold the stocks. With increased demand and less supply of the stocks (as the current investors will not sell the shares), the stock price will increase. This happens because of demand and supply forces and is considered the biggest factor in appreciating the stock’s price. Hence, the clientele effect, in this case, offers dual benefits to the investors: Dividend payout and Capital appreciation.

How to avoid a negative clientele effect?

When you invest in a company, you can only look at the current company policies. There is no way to predict what the policies may look like in the future if the company executives decide to change them. Hence, there is no way to know if the clientele effect will be positive or negative. However, one thing you can do is to choose a company that offers voting rights to its shareholders. When you have voting rights, you are included in the decision making of the company, and you can vote on the internal company matters. In such a case where you feel that a change in the company policy can be negative for your financial goals, you can oppose the change through your vote. However, if the change is positive, you can support the policy change and hold your investments.

Final words

The clientele effect describes the change in the price of a stock as a result of the change in its company policy. As all investors have a specific investment goal, the clientele effect suggests that investors will sell the holdings if there is a negative change in the company policy. If the sell volume increases over the buy volume, the share price of the company may decrease. With adequate knowledge of the clientele effect, you can ensure that you invest in stocks that can offer you good and consistent benefits.