JAMES TWYMAN: Reimagining equity research markets

South African financial services firms operating in the domestic equity and debt markets now have an excellent opportunity to reimagine their value proposition and approach to clients.

The recent departures of HSBC, Renaissance Capital and Macquarie, coupled with sharp contractions at many other companies, have provided ammunition for naysayers who use these disinvestments as “proof” that South Africa is becoming less attractive as an investment destination for foreign capital. While there is always a case for a blend of local and international market participants, it is also important to remember the specific context in which these departures are happening.

First, we need to consider the growing relevance of markets such as China and India. The JSE today has about 270 listed companies and a market capitalisation of about $1.5-trillion — a respectable value considering the size of the economy, but it pales in comparison to China, which has about 5,000 listings across the Hong Kong and Shenzhen exchanges, while the Bombay Stock Exchange has 5,309 listings. There were more than 100 IPOs in China in 2023, and more than 200 in India. International investment banks are refocusing their efforts on these larger, more strategically important jurisdictions, and markets such as South Africa are thus neglected.

The second factor is the regulatory environment in which we operate. After the 2008 global financial crisis, European regulators introduced the Markets in Financial Instruments Directive, updated in 2018, which expanded regulations beyond equities to cover all types of securities and derivatives.

This negatively affected the revenue that firms received for research, and it became unprofitable to produce research at such scale in Europe. These sorts of changes in the regulatory landscape make political decisions inevitable in big organisations. It often means that the necessary cost-cutting happens furthest away from the regional hub, which is often London, New York or Dubai, rather than where economics would actually suggest the attention should be focused.

This has had a large, direct impact on the research market in South Africa. It is not just the number of analysts that has declined, it is also the quality of the work, as coverage is spread much wider than it used to be. Analysts are covering a greater number of stocks and sectors than ever before.

A vibrant and sophisticated equity research market is critically important for several key reasons. Investors may gain clearer insights from it into a company's financial health, prospects and valuation, and this should ultimately support liquidity, broadening the knowledge of specific sectors and markets.

In addition, the coverage of smaller stocks suffers. There are now many listed companies for which Prescient Securities is the only stockbroker providing research, including Metair and City Lodge. These companies would have had up to five analysts covering them 10 years ago.

There are many other interesting businesses across key sectors where the coverage is limited. These companies are now paying for research to be provided, on their own terms. This is not the independent research that investors want, but they are having to accept it, often unknowingly.

One of the core reasons for listing on a bourse is to provide a secondary market for entrepreneurs who are building their businesses into valuable assets. A broad investor base means that they have the opportunity to access affordable growth capital and attract a premium on their equity if they wish to introduce new investors or exit their businesses over time. This is also a potential source of attracting foreign capital from investors who may be looking to acquire assets in emerging markets.

With the formation of the government of national unity and some successes through initiatives such as Operation Vulindlela, interest in South Africa is starting to pick up again. While it is coming off a low base, the JSE all share index has just completed its strongest third quarter in 11 years — near record highs.

It is important not to lose sight of the fact that we have a world-class financial services sector. Our banking sector is well governed and well respected, and the JSE is home to some quality investment opportunities. Businesses such as Shoprite, Naspers, Capitec and Bidvest have been sources of real wealth, along with smaller companies such as Afrimat, Combined Motor Holdings, Bytes/Altron and Karooooo.

For this ecosystem to truly thrive, we need to create an enabling environment where entrepreneurs can realise the value they create in their businesses. If we get this right, we can once again become a destination of choice for investment capital, which will, in turn, be a catalyst for further growth.

* Twyman is head of research at Prescient Securities