CHARL DE VILLIERS: Leveraging a shrinking JSE

Modern financial theory teaches us about the efficient market hypothesis, the crux of which is that asset prices immediately and fully reflect all new and available information, and that no amount of fundamental analysis can be used to generate excess returns.

As is often the case, the reality is often quite different to the theory. We firmly believe equity markets are not efficient, especially over shorter time horizons. That is due to  sentiment and human emotions, particularly fear and greed. Given the status quo in SA, the country’s pessimism is running at extreme levels, and understandably so. Within this context, it is easy to panic and look to max out your new Regulation 28 offshore limits regardless of valuation differentials across global markets.

JSE listing statistics from 1990 to 2022 show 747 companies were listed on the JSE over these 33 years, at an average rate of 22 new companies per annum. There has been a significant deceleration in the number of new listings over the past decade, with listings drying up over the past four years.

The delisting data shows 1,221 companies have left the JSE, at an average of 37 companies a year, well ahead of the average of 22 new listings a year. The net result of JSE listing and delisting figures is that there has been a reduction of 409 listed companies since 1990 on the JSE.

This is a 58% reduction from 713 listed companies in 1990 to only 304 by end-2022. This equates to about 12 fewer listed companies on the JSE each year since 1990. Delistings have also exceeded new listings in all but nine of the last 33 years.

Some of the drivers of the negative country context have undoubtedly played a role in the lack of new listings, mostly via constrained domestic growth and the knock-on effect this has on business confidence. It becomes easy to join the dots between the negative social and economic climate in SA to the lack of new listings on the JSE.

However, widening the frame of reference shows this is not only a localised phenomenon; many global bourses are suffering from a similar structural problem to that of the JSE.

Alternative assets

Why are fewer companies choosing to remain in the listed environment globally? The key may have something to do with new alternatives available to company owners that were not previously considered when looking to take that next step in their company’s evolution. The prolonged low-interest rate environment, coupled with quantitative easing, has increased investor risk appetite over the past decade. This led to a surge in the popularity of special purpose acquisition companies (Spacs), private equity and increased corporate M&A appetite.

The Spacs and private equity form part of the popular alternative asset cohort. The advantages associated with alternatives are that their performances are optically less correlated and less volatile than that of listed equity. This is because their valuations are provided less frequently and are open to a greater level of subjectivity on behalf of the asset managers until they exit the investments.

Some of the froth in the alternatives market is undoubtedly cyclical. We need to look no further than the recent implosions of various high-profile Spacs and several US banks that were instrumental in funding many of these new alternative asset vehicles. Transient capital in this space has started drying up as monetary conditions tighten.

Flows into passive products have blossomed over the past decade at the expense of active managers. By implication, a greater proportion of these exchange-traded fund flows ended up being invested in high-performing megacaps at the expense of their smaller, and arguably cheaper, smaller index-weighted listed peers that may have received more support from traditional value-orientated active managers, further compressing the ratings of many small to mid-sized companies that make up a big portion of the global listed cohort.

An element of this aggressive swing into passives may have been cyclical, particularly as many of these megacap names have suffered performance volatility over about the last year, and value as well as active management showed somewhat of a resurgence during the period.

But it is safe to assume this trend is unlikely to reverse materially as passives will remain an important building block for asset allocators. A consequence of this growing use of passive products is that company ownership trends are changing. Ownership by individuals has declined as institutional ownership has increased.   

The globalisation of equity market access is also allowing successful local companies to consider offshore listings, circumventing the JSE. This is a rational outcome given the discounted ratings of the local market.

The outcome of all these trends is that many smaller, locally listed companies no longer feel they are getting “bang for the buck” by remaining listed on the JSE. Furthermore, many of these companies frequently end up being acquired by larger listed peers or private capital that are opportunistically arbitraging the value differentials between small-cap and large companies.

These delistings provide alpha opportunities for nimble asset managers, with the stomach and patience to hold less popular, less liquid counters, the ability of which to generate sustainable cash earnings is underappreciated.

However, the overall trend remains concerning for SA asset managers, who benefit from a broader local investment universe when allocating their clients’ local assets.

• De Villiers is head of equities at Ashburton.