How Will Funds Handle Hewlett-Packard Company?

Fund managers are undoubtedly taking note of news that Hewlett-Packard Company HPQ plans to split into two separate companies.

According to reports, one company would focus on the printer and computer segments, with the other consisting of the corporate services and equipment unit.

When HP was dropped from the DJIA last year, the stock saw a sharp decline as fund managers sold shares. It since rallied, and as of early October, was off its September 52-week high of $38.25.

When A Company Splits

When a company splits in two, mutual funds holding the original entity can either hold shares of the new firm that results, or sell. If the new firm doesn't fit a fund's mandate, for whatever reason, funds may sell immediately, putting pressure on the new stock's price.

In the second quarter, the number of domestic mutual funds and hedge funds owning HP rose to 2,023 from 1,936. Institutional owners account for 78 percent of HP shares outstanding.

Consider that for a moment: Across the board, institutional trading accounts for about three-quarters of market movement; the HP ownership figures track that stat nicely.

The Dodge & Cox Stock Fund DODGX owns 3.85 percent of HP shares, constituting 4.13 percent of fund assets. Its sister fund, the Dodge & Cox International Stock Fund DODFX holds 2.59 percent of HP shares, for 2.55 percent of fund assets.

The Largest Holder

Will the largest holder, the Dodge & Cox Stock Fund, retain shares of both the parent company and the spin-off?

Perhaps there is a clue in the fund's strategy statement: “The Fund invests primarily in a diversified portfolio of common stocks. In selecting investments, the Fund invests in companies that, in Dodge & Cox's opinion, appear to be temporarily undervalued by the stock market but have a favorable outlook for long-term growth.”

Related Link: Morgan Stanley Thinks Hewlett-Packard Company Is Worth $48 to $50 Per Share

Not that anybody ever buys a mutual fund or ETF to get exposure to a particular stock; it's more to have a diversified investment in a specific asset class.

However, always keep in mind the effect that institutions have on share prices, and understand why institutional owners may choose to sell shares of a newly public company.