What is the Clientele Effect?

Many investors start investing in the stock markets when they start to earn. Young individuals use this regular source of income to cover their daily expenses and invest whatever they can save. They generally use these investments to achieve short-term goals, such as purchasing a house or a car.

Some investors may also want to invest to fulfil their long-term goals, like setting up a retirement fund. This is usually the case with investors who have a much lower risk appetite and want to invest in less volatile securities that can provide them with steady returns.

Today, investors have a wide range of companies to invest in, based on their risk levels and investments. For example, blue-chip stocks are generally less volatile, providing regular dividends to their shareholders. On the other hand, mid-cap stocks can be riskier and do not offer the benefit of regular dividends.

Here is where a theory called Clientele Effect comes into play. But before understanding the clientele effect, let’s understand the relationship between shares and investors.

Relationship between the shareholders and stock price

Purchasing a share deems investors as part-owners of the company in the proportion of the shares they own. They are also entitled to certain profits of the company in the form of dividends. Investors, as shareholders, also have certain voting rights. They can influence the company’s decisions, and ultimately, the company’s stock prices.

What is the Clientele Effect?

The clientele effect can be defined as the fluctuation in a company’s share prices in reaction to the demands, expectations, and goals of the shareholders. These shareholders may include mutual fund houses, financial institutions, or retail investors with their personal financial goals. Shareholders’ demands and expectations can be affected by the decision-making of the company’s senior management. Be it the change in dividend policy, taxes, or usage of funds - all these factors can affect the company’s share price.

Essentially, the main idea behind the clientele effect is that investors expect the company’s current policies to be consistent throughout the coming years, as per their financial goals and expectation. It is the reason why they invest in a company. Any deviation will be reflected in the company’s share prices.

How does the Clientele Effect work?

Both institutional and retail investors always look to achieve their long-term and short-term financial goals through the shares that they invest in. Every investment is based on certain expectations about the company that will help the investor achieve his/her goal. For example, investors with larger risk appetites, looking to substantially multiply their investments, can invest in highly volatile growth stocks, but also offer attractive upside potential. On the contrary, investors with a lower risk appetite may want low volatility and a steady dividend payout, even if it costs them a cap on price appreciation.

For example, you, as an investor have many high volatility stocks in your portfolio, and now you want to diversify your risk by investing in a low volatility stock, with a steady stream of income. Thus, you decide to invest in Company X’s share because of its current dividend policy that offers 20% of its profits payable as a dividend every year. However, after a while, Company X changes its dividend policy and now offers only 5% of its yearly dividends, moving forward. This decision by the company affects the future of your investments and alters the expectations that you previously had. As a result, you will end up selling Company X’s shares and look for another share that fulfills your investment goals.

Practically, if an individual decides to sell his shares, the stock price will not fall too significantly. However, if a large investor such as a financial institution or a mutual fund house decides to sell their stake in the company, there will be quite a substantial fall in the price of the stock. This is where the clientele effect can be seen.

Benefits of Clientele Effect

Although the Clientele Effect is generally deemed as a negative phenomenon, it can also have positive consequences. For example, if a company changes its policies and decides to increase the amount of dividend it distributes, this can be beneficial to the investors when it comes to fulfilling their financial goals.

Moreover, the Clientele Effect can come in quite handy in retaining a company’s current investors. As long as the shareholders are expecting a positive change in the company policy that will facilitate the fulfillment of their financial goals, they will hold their stocks, and attract potential investors with similar goals. This will lead to increased demand for the company’s shares and a consequent increase in share prices.

Thus, the Clientele Effect, if positive, can offer dual benefits to investors: increased dividend payout and capital appreciation.

How to avoid a negative clientele effect?

Needless to say, forecasting a company’s future policy decisions is not always possible. As an investor, you can only make an educated guess about which direction a company is headed in. Thus, there is no way to know whether the clientele effect will be negative or positive.

However, the investors do enjoy voting rights as shareholders of a company. They can vote on the internal matters of the company as per their interests. This way, if an investor feels that a company policy negatively affects his financial goals, he can oppose the decision by exercising his voting rights. Similarly, if a policy seems to benefit his financial goals, he can show support for the policy through his votes.

Final words

The Clientele Effect is a phenomenon that takes place when the expectations, demands, and goals of shareholders affect a company’s share price. If there is a negative clientele effect, investors will sell their holdings, resulting in a fall in the share price. If the clientele effect is positive, the share price of the company will increase. With knowledge about the clientele effect, an investor can take an informed decision about which company’s shares would fulfill his financial goals.