Active investment commentary & analysis

Does anyone care if stockmarkets survive?

Does anyone care if stockmarkets survive? Without fanfare, the pool of listed shares is fading in major markets like the US and UK. Capital markets are buckling under the weight of regulation and cost, and now look like an endangered ecosystem. That could mean that financing activity moves into riskier areas. Investors may need new strategies to capture growth.

Investors and companies benefit from being able to trade shares and raise capital. Stockmarkets have underpinned global growth, but over time the system seems to be getting weaker – with fewer listed equities available. And the remaining equities are gradually becoming less representative of the economy, missing out on the best growth opportunities. Much has moved on to the less transparent world of private markets.

The shrinking supply of equity in Western markets, combined with a lack of independent quality company research, gets little attention. The factors are complex – easy money, share buybacks, MiFID II, capital-lite business models, re-nationalisation and a dearth of IPOs. Estimates of stockmarket shrinkage range from 1.5% a year in the US, to much faster rates in the UK and Germany. Over time, this is steadily reducing listed equity supply. And the trend has been noted for at least a decade, making it hard to blame recent trade wars.

Undoubtedly, low bond yields have made equity look more expensive for companies, and in a world of low growth, management reward can be easily engineered through share buybacks. High rewards for staying private mean that IPOs are delayed or may never happen.

Regulation has focused on “low cost”, but there is more to stockmarket efficiency. Companies can best access equity capital at fair cost if share prices properly reflect the opportunity. The problem may be that stockmarket prices are a free good - available to all investors without payment. But free does not mean without cost. Setting “correct” share prices involves research; work on company accounts, meeting management and independent thought.

Who should pay? Since MiFID II, more of the burden has fallen on active managers. Some wonder whether they should be the ones making all the effort, when passive funds use these share prices do not pay. Costs become hidden; in wider dealing spreads, patchy liquidity and share prices that might move well out of line with fundamentals. Smaller stockbroking firms with reduced turnover are forced to focus on their corporate clients. The volume of research may still be there, but is becoming increasingly conflicted. Or nasty stockmarket surprises can be expected, with bad companies lacking scrutiny.

Companies are staying private for longer. Regulation and competitive pressure in Europe has moved more investors into trusting share prices blindly through index investment. Investors wanting the higher growth businesses that used to list automatically, must take on more risk if they choose private markets. Stockmarkets are becoming a smaller space – and riskier without independent professional research.