Corporate actions are events initiated by a company that affect its securities and, consequently, its shareholders. These actions can influence stock prices, shareholder equity, and the overall financial health of the company. Therefore corporate action have an economic impact on the shares. As a result they economic impact on the index funds managed at SAMA.

The Portfolio Manager decides how to respond to corporate action. Like any other PM decision this affects fund performance. In order ot provide required information for those decisions or to implment mandatory events requires set of dedicated tools. Futhermore, annoucements of corporate events, applicable entitlements, confirmations and communications between stakeholders requires dedicated operational teams operating within agreed time and perimiter.

Corporate actions affecting the value of securities in the fund’s portfolio will impact the fund’s Net Asset Value (NAV), influencing the value of the managed funds.

Document

Purpose of this document is to describe the Corporate Actions Process at SAMA, walk through the implemented process, main tools as well as to describe key Corporate Events and their impact ont he equity indexes and equity funds.

General Impact and Considerations

Portfolio Managers adjusts portfolio holdings to mirror any changes in the index caused by corporate actions to maintain accurate tracking. There are three main drives for his or her decision:

Valuation Adjustments: Corporate actions can alter the market capitalization of index constituents, affecting their weighting in the portfolio.

Cash Management: Dividends and special distributions impact the portfolio’s cash flow and require decisions on reinvestment.

Regulatory Compliance: Ensuring all adjustments comply with investment guidelines and regulatory requirements.

Those drivers are

Operational Efficiency: Corporate Actions occur very frequently. Portoflio Management team responsible for multiple funds must find the right balance between acting and analizing events. Too frequent adjustments to portoflio might not be operationally efficient and can increase operational and human error risk.

Timely Execution: Depends on the index implmenetation, the timing of a response to corporate actions minimizes tracking error and maintains portfolio performance in line with the index.

Cost Management: Frequent adjustments can incur transaction costs; efficient execution strategies are necessary to minimize impact.

Communication: Keeping management and compliance informed about significant changes due to corporate actions enhances transparency and trust.

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Monitoring

They require careful monitoring and timely responses to ensure that the portfolio continues to accurately reflect the underlying index and meets its investment objectives.

Types

Categories

Classification is important for several reasons, including cash flow management, tax implications, accounting treatment, and investment decision-making.

Cash Events

1. Cash Dividends:
   • Distribution of a portion of the company’s earnings to shareholders in cash.
   • Immediate income for shareholders but reduces the company’s cash reserves.
2. Share Buybacks (Repurchases):
   • Company buys back its own shares from the market, returning cash to shareholders who sell their shares.
   • Can increase earnings per share (EPS) by reducing the number of outstanding shares.
3. Cash Mergers and Acquisitions:
   • Shareholders receive cash in exchange for their shares when a company is acquired.
4. Liquidation Distributions:
   • Cash payments made to shareholders when a company liquidates its assets.

Non-Cash Events

1. Stock Dividends:
   • Shareholders receive additional shares instead of cash.
   • Increases the number of shares held without changing the total value of the investment.
2. Stock Splits and Reverse Stock Splits:
   • Adjust the number of shares outstanding and the price per share.
   • Stock Split: Increases shares and reduces the price per share proportionally.
   • Reverse Stock Split: Decreases shares and increases the price per share proportionally.
3. Mergers and Acquisitions (Share Exchange):
   • Shareholders receive shares of the acquiring company instead of cash.
4. Spin-offs:
   • Company distributes shares of a subsidiary or division to existing shareholders, creating a new independent company.
5. Rights Issues:
   • Shareholders receive rights to purchase additional shares at a discount.
   • The initial receipt of rights is non-cash, but exercising them involves cash payment.
6. Bonus Issues:
   • Free additional shares issued to shareholders, similar to stock dividends.

Corporate Actions

1. Dividends

• Cash Dividends: Companies distribute a portion of their earnings to shareholders in cash. This affects the income of the portfolio and requires reinvestment decisions.
• Stock Dividends: Additional shares are issued to shareholders, increasing the number of shares held without changing the total value initially.

2. Stock Splits and Reverse Stock Splits

• Stock Splits: Companies increase the number of shares outstanding by splitting existing shares (e.g., 2-for-1 split), reducing the share price proportionally.
• Reverse Stock Splits: Companies decrease the number of shares outstanding by consolidating shares (e.g., 1-for-10 reverse split), increasing the share price proportionally.

3. Mergers and Acquisitions (M&A)

• Mergers: Two companies combine to form a new entity, potentially altering the index composition if one or both companies are index constituents.
• Acquisitions: One company purchases another, which may lead to the acquired company’s removal from the index and adjustments in the portfolio.

4. Spin-offs

• A parent company distributes shares of a subsidiary or division to its shareholders, creating a new independent company. This requires adjustments to hold the new shares if they are included in the index.

5. Rights Issues

• Companies offer existing shareholders the right to purchase additional shares at a discounted price. Fund managers must decide whether to exercise these rights to maintain proportional holdings.

6. Share Buybacks (Repurchases)

• Companies buy back their own shares from the market, reducing the number of outstanding shares and potentially increasing the share price. This can affect the company’s weight in the index.

7. Delistings

• Companies are removed from stock exchanges due to mergers, bankruptcies, or failure to meet listing requirements. The portfolio must remove these holdings accordingly.

8. Index Rebalancing

• Periodic Rebalancing: Index providers periodically adjust the constituents based on market capitalization, sector representation, or other criteria. Portfolios must realign holdings to match.
• Special Rebalancing: Occurs due to significant corporate actions like large mergers, requiring immediate adjustments.

9. Tender Offers

• A company or investor offers to purchase shares from shareholders, often at a premium. Participation decisions affect holdings and portfolio performance.

10. Bonus Issues

• Companies issue additional shares to shareholders at no extra cost, similar to stock dividends, increasing the number of shares held.

11. Special Dividends

• One-time distributions that are larger than regular dividends, often resulting from asset sales or surplus cash. They can impact the portfolio’s cash position and income.

12. Name and Ticker Changes

• Administrative changes where a company changes its name or stock ticker symbol, requiring updates to portfolio records.

13. Bankruptcy and Liquidation

• Companies facing financial distress may declare bankruptcy, leading to a potential loss of investment and removal from the index.

14. Initial Public Offerings (IPOs)

• New companies are added to the index post-IPO if they meet the inclusion criteria. The portfolio must purchase shares to include the new constituent.

15. Currency Conversions (for International Portfolios)

• Companies may change the currency denomination of their shares, affecting valuation and requiring currency adjustments in the portfolio.

16. Reorganizations and Restructurings

• Significant changes in a company’s structure, such as changing its country of domicile or legal structure, which may affect its index eligibility.

17. Warrants and Options Issuance

• Companies issue derivatives that may dilute share value or require portfolio adjustments if they convert into common stock.

18. Exchange Offers

• Companies offer shareholders the option to exchange their holdings for different securities, potentially affecting the portfolio’s asset mix.

Companies Involved: Company Alpha and Company Beta

A. Merger Example

Companies Involved: Company Alpha and Company Beta

• Scenario:
  • Both are major players in the technology sector and index constituents.
  • Announce a merger to form Company Gamma.
• Merger Terms:
  • Shareholders of Alpha receive 1 share of Gamma for every 2 shares of Alpha.
  • Shareholders of Beta receive 1 share of Gamma for every 1 share of Beta.
• Index Impact:
  • Company Gamma replaces Alpha and Beta in the index.
  • Index weight adjusted based on Gamma’s market cap.
• Portfolio Actions:
  • Sell holdings in Alpha and Beta.
  • Purchase appropriate number of Gamma shares to match index weighting.

B. Acquisition Example

Companies Involved: Company Delta (Acquirer) and Company Epsilon (Target)

• Scenario:
  • Delta is a large pharmaceutical company; Epsilon is a biotech firm and an index constituent.
  • Delta acquires Epsilon for $100 per share in cash.
• Acquisition Outcome:
  • Epsilon is delisted post-acquisition.
  • Delta’s market cap increases, potentially affecting its index weight.
• Index Impact:
  • Epsilon is removed from the index.
  • No addition unless Delta’s increased market cap alters its position.
• Portfolio Actions:
  • Receive cash for Epsilon shares.
  • Reinvest cash into other index constituents to maintain tracking.

Definition

Dividends are distributions of a portion of a company’s earnings to its shareholders. They serve as a reward for investors and are typically declared by the company’s board of directors. Dividends can be paid in cash or additional shares and are a key indicator of a company’s financial health and profitability.

Types of Dividends

1. Cash Dividends

• Description: Direct cash payments made to shareholders, usually on a per-share basis.
• Frequency: Often paid quarterly but can also be semi-annually, annually, or as special one-time payments.
• Impact on Company:
  • Cash Outflow: Reduces the company’s cash reserves.
  • Financial Ratios: Affects liquidity and possibly leverage ratios.
• Impact on Shareholders:
  • Income Generation: Provides immediate income.
  • Taxation: Generally taxable as income in the year received.

2. Stock Dividends (Bonus Shares)

• Description: Additional shares issued to shareholders proportional to their existing holdings.
• Impact on Company:
  • No Cash Outflow: Preserves cash for operational needs.
  • Share Dilution: Increases the total number of shares outstanding.
• Impact on Shareholders:
  • Ownership Percentage: Remains the same, but the number of shares held increases.
  • Share Price Adjustment: Market adjusts the share price downward proportionally.

Impact on Index Composition

Cash Dividends

• Index Calculation:
  • Price-Weighted Indices: Typically not adjusted for dividends; index value remains unchanged.
  • Total Return Indices: Account for dividends by reinvesting them, reflecting total shareholder return.
• Portfolio Management:
  • Reinvestment: Funds may reinvest dividends to maintain index tracking.
  • Cash Handling: Requires effective cash management to minimize tracking error.

Stock Dividends

• Index Adjustment:
  • Share Count Increase: Index providers adjust the number of shares to prevent distortion.
  • Price Adjustment: Share price decreases proportionally; index value remains consistent.
• Portfolio Management:
  • Automatic Adjustment: Holdings adjust naturally with the stock dividend.
  • No Cash Impact: Simplifies portfolio adjustments since no cash transactions are involved.

Impact on Investment Portfolios

For Index Funds and ETFs

• Cash Dividends:
  • Income Distribution: May be passed on to investors or reinvested, depending on fund policy.
  • Tracking Error: Proper handling is crucial to minimize deviations from the index performance.
• Stock Dividends:
  • Share Adjustment: Funds receive additional shares, maintaining alignment with the index.
  • Simplified Management: Easier to handle compared to cash dividends due to lack of cash flow.

For Active Portfolios

• Investment Strategy:
  • Income Focus: Dividends contribute to total return; attractive for income-oriented investors.
  • Reinvestment Decisions: Managers decide whether to reinvest dividends or allocate elsewhere.
• Tax Considerations:
  • Tax Efficiency: Strategies may vary based on the tax implications of receiving dividends.

Considerations for Companies

• Signal of Financial Health:
  • Regular Dividends: Indicate consistent profitability and confidence in future earnings.
  • Dividend Changes: Increases can signal growth, while cuts may raise concerns.
• Capital Allocation:
  • Balancing Act: Deciding between returning profits to shareholders or reinvesting in the business.

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Conclusion

Dividends are a fundamental corporate action with significant implications for companies, shareholders, and investment portfolios. For companies within an index:

• Index Alignment: Proper handling ensures that indices accurately reflect company performance.
• Portfolio Impact: Dividend management affects income generation and portfolio balancing.
• Investor Relations: Dividends play a key role in attracting and retaining investors.

Understanding the nuances of dividends helps investors make informed decisions and allows portfolio managers to maintain alignment with investment objectives and index benchmarks.