Marc Ter Mors: Leadership change in SA has boosted interest from global investors. Picture: Russell Roberts
Marc Ter Mors: Leadership change in SA has boosted interest from global investors. Picture: Russell Roberts

Local institutional brokers continue to hold their own against the heavyweight international players in the Financial Mail’s Ranking the Analysts survey. A clear feature of this year’s results is the consistency of firms and analysts at the top of the many ranking categories compared to last year.

The survey findings come at a time when the equity market is upbeat because the country’s new political leadership has ignited renewed international interest in SA as an investment destination. However, the local market is also grappling with new regulatory requirements in Europe, the second Markets in Financial Instruments Directive (MiFID ll), that have forced many local players to change their business models. There is also a real fear that MiFID, which became effective in Europe and the UK on January 1, might result in further barriers to transformation within SA’s investment research sector — which remains predominantly white and male after nearly 25 years of democracy.

Standard Bank/SBG Securities heads the overall rankings for the third consecutive year, firmly establishing itself as SA’s top research firm.

RMB Morgan Stanley, the joint venture between Rand Merchant Bank and US firm Morgan Stanley, maintains second place, also for the third year in a row. Deutsche Securities and UBS SA maintain their third and fourth rankings while JPMorgan moves up to fifth, from sixth last year.

Macquarie also moves up, from seventh to sixth, while Renaissance Capital jumps from ninth to seventh and HSBC Securities improves from 10th to eighth. Avior Capital Markets and Citigroup Global Markets are ranked ninth and 10th.

Individual analysts in the main categories maintained their top rankings: David Ferguson of Rencap in media, a category that has grown in importance because of the size of Naspers; Stephan Potgieter (UBS) in banks and Sean Holmes (Deutsche) in general retailers.

Walter de Wet, who moved to Nedgroup Securities from Standard Bank/SBG Securities in November, takes top spot in fixed interest securities while Macquarie’s Rowan Goeller is the top-rated analyst for diversified industrials.

Of the 40 research categories this year, 15 have new top-ranked analysts.

Ramaphosa effect

Marc Ter Mors, head of equity research at SBG Securities, says his firm definitely noted a "confidence rerating" since the leadership changes in SA. "There is definitely increased interest from international investors, based on prospects of business-friendly policies and an economic recovery," he says, emphasising though that these remain prospects.

Based on the same confidence drivers, he says local funds have also reacted, moving out of cash positions into domestically orientated stocks. There has also been a marked increase in initial public offering (IPO) activity.

He says it is not only SA assets but wider African assets that have attracted renewed interest.

One top-ranked analyst who preferred not to be named confirms the renewed interest in SA but notes that it is in particular sectors. "Clearly SA Inc — banks, retailers and industrials — are where a lot of foreign investors are focusing," he says.

The mining sector, he says, has attracted international interest as its prospects are perceived to be better from a regulatory point of view. Perversely though, he says the initial strengthening of the rand following Cyril Ramaphosa’s ascension to the ANC and SA presidency is negative for mines. "So, there is more certainty in the longer run but expectations of nearer-term profits are diluted."

When on international roadshows, he says some investors have drawn parallels between SA now and India when Narendra Modi was elected prime minister in 2014, promising business-friendly policies and market reforms. "Then the market wasn’t cheap and there was a view from international investors that if you buy only on a value basis you would miss out on huge upside. Terms like ‘valuation agnostic’ were thrown around. That’s the type of enthusiasm we saw initially for SA. Already there’s been a bit of a reality check."

MiFID II

Among various measures, MiFID ll states that fees for research should be separated from execution, referring to the actual trading of securities. Traditionally the investment houses bundled the fees they charged for selling their research to asset managers and others with the execution fees.

While it is not a legal requirement in SA, asset managers who do business with international institutional investors will need to comply in order to be eligible to service those investors, and many local firms began adapting to the directive prior to it becoming effective this year. As part of this year’s Ranking the Analysts survey we asked asset managers whether there was an explicit policy to pay for research as a distinct line item from execution and other services. Of the 22 firms that responded, 45.5% said yes.

From the fund manager’s point of view, the costs of research will generally have to be borne by the firm, whereas the cost of execution can be wrapped into client fees. The concern among sell-side analysts is that this will inevitably put pressure on the budgets that asset managers set aside to cover the cost of research.

The directive imposes a dramatic revision of established market practices but a more hidden, unintended consequence is that it could make it more difficult for black professionals to establish small, independent practices. The added costs of research, for example, might reduce resources allocated to the development of young black professionals by the bigger established players. On the other hand, research spending will no longer be tied to large brokerage houses, creating space for independent nonbroker research analysts to service asset managers.

Shamil Ismail: Transformation in SA’s investment sector is in urgent need of remedial action. Picture: Hetty Zantman
Shamil Ismail: Transformation in SA’s investment sector is in urgent need of remedial action. Picture: Hetty Zantman

As it is, transformation in SA’s investment sector is in urgent need of remedial action, says Shamil Ismail, founder of independent sell-side research firm Primaresearch. Primaresearch conducted a demographic analysis of the 2017 Financial Mail analyst rankings on behalf of the Association of Black Securities & Investment Professionals (Absip). Key findings were:

• The number of black SA sell-side analysts was stable at around 51-54 for the three years 2014 to 2016, then increased sharply to 66 in 2017. The universe was about 465 analysts.

• Excluding those included as part of teams, there were only 33 black SA analysts individually ranked in 2017 and only nine were black Africans.

• The proportion of black SA analysts increased from about 12% in 2014-2016 to 14.2% in 2017.

• Only 17 black analysts were rated in the top six in their categories (out of 240 available slots).

• The proportion of female analysts on the sell-side has remained stable at 18%-20%.

Ismail says the findings are "disturbing" and an indictment against the sell-side sector. "It is 2018 but we still have sub-20% transformation and that is something that needs to be considered carefully. We really need to put in some remedial actions," he says.

The Association of Black Securities & Investment Professionals Stock Broking Think Tank, a substructure of Absip, believes that the response by local investment managers to MiFID ll could further suppress transformation. However, it believes MiFID ll could be used "as a unique opportunity to drive real change in the industry". Absip is hoping that the SA market responds in favour of the latter.

This could be done by creating a separate pool of allocations for black-owned and managed securities firms in the industry.

A big issue for asset managers is whether to pass on research costs to their clients. Most commentators say they won’t be able to do so. Of those asset managers who already pay for research separately, 36.4% said they expensed it to their gross profit & loss, with the balance saying it formed part of fees charged to clients.

Delphine Govender, speaking on behalf of the Absib Stockbroking Think Tank, says it is not common practice to manage only a single fund that can easily be debited and the costs applied distinctly to that account. "Many managers will consume research whose benefits are hopefully felt across the majority of funds under management and therefore the difficulty is to accurately apportion research costs across all accounts. Remember, the research will be procured and consumed only once but felt across all or most underlying funds."

Delphine Govender: Research costs across all accounts need to be accurately apportioned. Picture. Hetty Zantman Hetty Zantman
Delphine Govender: Research costs across all accounts need to be accurately apportioned. Picture. Hetty Zantman Hetty Zantman

Adding research costs to their own profit & loss accounts will further squeeze smaller assets managers — a factor that makes it more difficult for small black investment houses to establish themselves. Ter Mors says that is likely to result in them cutting the number of brokers they use to regional specialists and international players, a trend already noticeable in Europe and the UK.

Ismail says local asset managers have already started trimming their broker lists, limiting the number of parties they pay research fees to. "And the more asset managers do that, the more attrition there will be on the sell-side."

Asset managers need the best execution at the best price, as they try to find the best deals for their clients, he says. "There’s no reason to pay 20 basis points when you could pay 10; there is already a consistent downward trend in rates. MiFID will separate the discussion; the buy side will decide on the best rate of execution, then ask how much they are going to pay for research. Research should be a fixed fee, it shouldn’t rise with the size of a trade."

Ismail founded Primaresearch in 2015 aware of the pending regulations and making a dedicated research house only, not a brokerage. "We have a few ways that clients can pay us," he says. "We have commission-sharing arrangements, they can pay us directly and we have a subscription model typically for smaller clients. MiFID won’t affect us that much — it could actually allow us to gain traction with some clients."

Ter Mors says it’s still too early to assess the financial impact of MiFID within SA; it will play out over the year. SBG has been signing product agreements, such as prepayments and other payments derived from service levels.

Having asset managers taking on research costs could be disruptive to smaller research houses and asset managers, he says. "The risk of unintended consequences could be that MiFID makes the larger firms stronger and the smaller ones weaker — both asset managers and research houses." Should this scenario play out in Europe, he expects it to attract regulator interest in trying to establish a more competitive landscape. "We’d expect regulators to be interested in enhancing competition, not diminishing it."

Another issue that still needs sorting out is to separate out costs of corporate access, referring to the practice of brokers arranging for asset managers to visit or meet with executives from listed companies. While that was not part of MiFID, Ter Mors says it has become an issue. "It’s still uncertain how asset managers in the MiFID regions are able to utilise corporate access. Over the course of the year we’ll see how that solidifies."

Asked which they considered optimal, 62% of the 26 asset managers that responded said remuneration for corporate access should be covered by brokerage; 21% said it should be remunerated separately with specific fees for the service; 12% said it should be provided at no cost; and 6% said the broker should be compensated for facilitating the meeting.

Ter Mors says another issue is that as asset managers cut back on the number of research houses they use, it is also likely to reduce the coverage of small and medium-cap stocks. Furthermore, instead of 20 analysts covering a stock, it’ll probably come down to nine or 10. "That has consequences for market efficiency and effectiveness over the long term. Maybe there was overcapacity.

"Much is still uncertain and it results in short-term pressures. But it may be positive over time. MiFID facilitates research becoming a proper own business over time. Price discovery will probably return once it’s all consolidated."

Read the full report here.

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