GEOFF COOK: Changing the mindset
The steady decline in listings of small and medium-sized companies on the JSE is attributable to a negative economic cycle and investor sentiment
Believing that the SA capital market will recover when the economic cycle reverses its downward trend somewhat misses the point. There can be no economic upturn without a vibrant capital market to drive growth in the first place.
From a simplistic traditionalist perspective, the steady decline in listings of small and medium-sized companies on the JSE is attributable to a negative economic cycle and investor sentiment.
The paradox is that the US and Europe are experiencing a similar decline, despite having growing economies, while our emerging-market peers have undergone significant growth in listings in the small to medium sector.
So, SA’s problem is not just economic. It’s structural. The JSE’s market structure inadvertently marginalises smaller companies and retail investors.
The decision to list is a trade-off between the expected benefits (access to capital, ability to use shares as a currency, liquidity for shareholders, raised profile) and costs (increased costs and regulatory burdens, transparency, loss of control, short-termism).
Economic and regulatory factors aside, small and medium companies clearly feel that the JSE listing trade-off is not worth it and are instead looking to the private equity market.
Their biggest impediments to listing are a lack of liquidity and the increasing cost and burden of regulation.
Liquidity is a complex subject but, in essence, it encapsulates the ability to facilitate large volumes of trade in a particular share without causing excessive price movements, while still reflecting a fair market price.
A liquid market requires lots of buyers and sellers and can be facilitated by traditional market makers or algorithmic and high-frequency traders.
The JSE’s market structure inadvertently marginalises smaller companies and retail investors
In terms of buyers and sellers, the JSE is one of the most concentrated equity markets in the world, with about 99% of equity flows attributable to institutional investors. In developed economies retail investors account for at least 10% of equity flows.
Relative wealth per capita is not enough to explain the fact that only 1% of SA equity flow is retail.
In addition, the bulk of the institutional flows are invested in the top 40 shares, making such shares (mostly) highly liquid.
Smaller companies are the casualties.
In terms of facilitation, the JSE encourages competition between algorithmic and high-frequency traders. However, a recent study by the European Central Bank concluded that such competition actually compromises both the quantity and quality of liquidity.
There’s no lack of retail investor interest. But the high barriers to entry to holding a JSE stockbroking account preclude the average retail investor from directly investing on the exchange.
This results in a tiny pool of investors.
Retail investors have also been lost to the asset management industry, where assets under management have grown from R248bn in 2005 to R2.45-trillion as at June 2019.
Ironically, this has contributed to the decline in JSE listings. As the average size of a fund grows, so does the quantum of minimum investment it must make to "move the needle".
But this quantum cannot result in the fund having an exposure to a company or sector in excess of that prescribed by the fund mandate or by regulation.
Active managers are also competing against the success and growth of index-tracking passive investments. These factors are forcing funds to mostly invest in top 40 companies despite there being value in smaller companies.
Compounding the problem, negative sentiment regarding SA Inc has driven funds to seek more exposure to foreign rather than domestic companies.
In fact, out of the 1,592 active local funds, as at June 30 this year, only 10 focused on small and medium-sized companies.
In the absence of institutional investors and an increasingly limited retail investor base, smaller companies listed on the JSE will continue to experience poor liquidity and low valuations. An economic upturn will not resolve the listing trade-off.
Beyond tax incentives and regulatory initiatives that seek to drive liquidity in smaller companies, the industry needs to proactively tilt the trade-off in favour of listing.
That process has begun.
ZAR X is already revitalising the market by using technology to drive financial inclusion so as to attract an untapped pool of retail capital. It provides companies wanting to access this capital with a flexible principles-based listings regime that reduces the listing burden and costs without compromising governance or international standards.
ZAR X’s broad spectrum of listings, with a large retail investor base, belies the negative environment, with comparable high levels of trading liquidity verifiable in the comparative valuations of the companies.
It proves that a mindset change is all the market needs.
• Cook is the executive director of ZAR X