Contractual savings flowed into institutionally managed funds, whether endowment policies, defined contribution pension funds, provident funds or retirement annuities. Discretionary savings have flowed into institution-run mutual funds — formerly mutual funds — and tax-free savings accounts.
These flows are all, at least in part, based on the significantly better tax treatment these products enjoy compared to other forms of savings, such as personal stock portfolios.
What’s remarkable about these tax incentive savings products is that they all have a financial institution as their custodian – you can’t access the tax incentive unless you give up at least 1%, or perhaps 2%, of your assets in fund management fees each year. It is therefore not surprising that the market has become increasingly institutionalized since institutions obtained a collective monopoly on access to tax incentives for retail savers.
However, there have been real consequences for the health of the market.
So now only 11 asset management groups manage around 90% of all local funds under management, and like foreign investors who hold around 38% of all public market assets in South Africa, these institutions only invest than in large and liquids.
It is common for representatives of these institutions to blithely assert that only the 100, or at best perhaps 140, of the largest, most liquid listed companies in South Africa are ‘investable’.
Here they mean investable for them in all circumstances, at all costs. The 190 or so remaining listed companies can never hope to arouse the interest of these institutions, on criteria totally unrelated to anything other than size and liquidity.
So, should private exchange clients fill the void? Unfortunately, this is no longer the case.
Over the past decade, most stockbrokers have moved to increase their share of investors’ wallets by transforming themselves into financial advisory and intermediary services act-regulated wealth managers, and shifting their income from brokerage commissions volatile trading to stable and predictable management and advisory fees. .
Most have changed their names to reflect this change in their activities. “Stock brokers” and “securities” are out, and “wealth” and “investments” are in.
They have worked very hard to move their clients to constructed mutual fund portfolios or indexed model portfolios. Unfortunately, these funds have the same limited investment universe as the 11 dominant asset managers.
This institutionalization of the market is reflected in the inability of growing companies to raise primary capital and therefore in the decreasing number of new listings – most companies, for reasons of size and liquidity alone, can expect to be excluded from the investable universe, and will therefore never be able to raise primary capital regardless of their prospects. And here, smaller companies include companies with multi-billion rand market caps.
These same companies struggle to find institutions that would even deign to assign a junior analyst to meet with the company’s CEO, or feel no shame in accepting a request for a meeting and then canceling it after the CEO has already flew to Cape Town.
Traditional stockbrokers, now dubbed wealth managers, aren’t even allowed to discuss upcoming IPOs or new stock issues with clients if the business isn’t pre-approved by a committee and placed on the approved list – and small businesses cannot be on the list.
So, from the perspective of any company outside of the limited institutional investment universe, our public markets are deeply broken.
The link between long-term individual savers as providers of capital and most listed companies has been broken.
It is therefore not surprising that the number of companies listed in South Africa has more than halved over this same 30-year period. This decline is expected to accelerate and it is likely that the JSE will have fewer than 300 listed companies by the end of 2022, compared to 760 30 years ago.
In these institutionalized circumstances, South African public markets can therefore no longer fulfill one of their main societal purposes as a source of capital for new and growing businesses.
This phenomenon is not entirely unique to South Africa.
Fewer companies are also listed on other markets. A popular explanation for the downsizing in Western economies is the growing ability of companies to access private capital from venture capital and private equity firms. Anyone familiar with the South African venture capital and private equity market would quickly realize that these local industries are tiny and play an insignificant role in providing capital to new and growing local businesses. This explanation does not work here.
So what is the solution? We have to go see those dynamic markets where at least some small companies are able to raise primary capital. Australia and Canada come to mind for their vibrant resource sectors – the US for tech companies and the UK for the LSE’s AIM market for small businesses.
Interestingly, all of these countries moderated the ability of their financial institutions to collectively monopolize access to tax incentives. Australia offers self-directed super funds, Canada offers self-directed registered pension plans, the United States offers self-directed individual retirement accounts, and the United Kingdom offers self-invested personal pensions.
All of these plans allow individual investors to manage part of their retirement savings themselves while benefiting from the tax incentives offered by the governments of these countries.
South Africa, despite our love of adopting much of the regulatory innovation from other markets, has never seen fit to allow such products.
By offering these products, these markets recognize, first, that providing investor choice is in itself a good thing and, second, that by providing a diversity of investors to the public markets, the public markets benefit.
These countries value the participation of small investors in their markets so much that they go further with other incentives.
For example, in Canada, investments in publicly traded mineral exploration companies can be made from pre-tax income and deducted from the individual’s tax liability – so-called flow-through shares.
In the UK, investing in companies on the AIM market attracts a range of tax incentives, and in particular investment by individual investors in companies listed on AIM does not attract tax on the most -values.
We must begin to repair the damage caused by the institutionalization of our market – by excluding diversified and smaller investors.
Individual investors should be able to access the tax incentives due to them on their own, without having to pay an institution a fund management fee for this privilege.
We need to go further by also offering direct incentives to retail investors to participate in the raising of primary capital by companies outside of the institutional investable universe.
Without positive action to repair the damage, it is inevitable that the number of listings on local public markets will continue to decline; local public markets will continue to fail in their societal purpose as an efficient venue for raising primary capital; and the JSE will soon host a maximum of just those roughly 140 companies deemed investable by the 11 dominant asset managers. BM/DM