How to fix our broken public capital markets after institutional monopoly

Contractual savings have flowed into institutionally managed funds, be they endowment policies, defined contribution pension funds, provident funds or retirement annuities. Discretionary savings have flowed into institutionally managed collective investment schemes – previously unit trusts – and tax-free savings accounts. 

These flows are all, at least in part, based on the materially better tax treatment that these products receive relative to other forms of savings, like personal share portfolios.  

What is notable about these tax incentivised savings products is that all of them have a financial institution as a gatekeeper – you cannot access the tax incentive unless you give up at least 1%, or perhaps 2%, of your assets as fund management fees every year. It is no wonder, then, that the market has become ever more institutionalised when institutions have been granted a collective monopoly on access to retail savers’ tax incentives.  

There have, however, been real consequences for the health of the market.

So now, just 11 asset management groups manage roughly 90% of all local funds under management, and like the foreign investors who own about 38% of all public market assets in SA, these institutions invest only in the large and the liquid.  

It is routine for representatives of these institutions to blithely state 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 under all circumstances, at any price.  The remaining 190 or so listed companies can never expect to attract these institutions’ interest, on criteria entirely unrelated to anything except size and liquidity.

So, private stockbroking clients must be filling the gap? This is unfortunately no longer the case. 

Most stockbrokers have, over the past decade, set out to increase their share of the investors’ wallet by transforming into Financial Advisory and Intermediary Services Act regulated wealth managers, and moving their revenue from volatile trading commissions to steady, predictable investment management and advisory fees. 

Most have rebranded to reflect this change in their businesses. Out went “stockbroking” and “securities”, and in came “wealth” and “investments”. 

They have worked very hard to move their clients into constructed portfolios of collective investment schemes or index benchmarked model portfolios. Sadly, these funds have the same limited investable universe as the 11 dominant asset managers. 

This institutionalisation of the market is felt in the inability of growing companies to raise primary capital and thus in the diminishing number of new listings – as most companies, for reasons only of size and liquidity, can expect to be excluded from the investable universe, and thus will never be able to raise primary capital regardless of their prospects. And here, smaller companies include companies with multi-billion-rand market capitalisations.  

These same companies find it difficult to find institutions that will even deign to allocate a junior analyst to meet with the company CEO, or feel no shame in accepting a meeting request and then cancelling it after the CEO has already flown to Cape Town.  

Traditional stockbrokers, now branded as wealth managers, are forbidden from even discussing upcoming IPOs or new share issues with clients if the company isn’t pre-vetted by a committee and placed on the approved list – and smaller companies cannot get on to the list. 

So, from the perspective of any company outside the limited institutional investable universe, our public markets are profoundly broken. 

The link between long-term individual savers as capital providers and most listed companies has been severed.

It is therefore no surprise that the number of listed companies 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 trading by the end of 2022, down from 760 30 years ago. 

Under these institutionalised circumstances, the South African public markets can thus no longer fulfil one of their primary societal purposes as a source of capital for new and growing companies.

This phenomenon is not entirely unique to South Africa. 

Fewer companies are listing on other markets too. A popular explanation for the reduction in listings in Western economies is the increasing ability of companies to access private capital from venture capital and private equity firms. Anyone with knowledge of the South African venture capital and private equity market would quickly realise that these local industries are tiny and play an insignificant role in providing capital to new and growing local companies. This explanation doesn’t work here.

So, what is the solution? We must go and look at those dynamic markets where at least some smaller companies are able to raise primary capital. Australia and Canada come to mind for their lively resource sectors – the US for tech companies and the UK for the LSE’s AIM market for smaller companies.  

Interestingly, all these countries have moderated their financial institutions’ ability to collectively monopolise access to tax incentives.  Australia offers Self-Managed Super Funds, Canada offers Self-Directed Registered Retirement Plans, the US offers Self-Directed Individual Retirement Accounts and the UK offers Self-Invested Personal Pensions.  

All these plans allow individual investors the choice to manage a portion of their retirement savings themselves while still enjoying the tax incentives those countries’ governments provide.  

South Africa, despite our love of adopting much of the regulatory innovation of other markets, has never seen fit to allow such products.

By providing these products, those markets acknowledge, first, that providing choice to investors is in and of itself good and, second, that by providing a diversity of investors to the public markets, the public markets benefit.

These countries value smaller investor participation in their markets so much that they take it further with other incentives.  

For example, in Canada investment into listed mineral exploration companies can be made from pretax income and written off against the individual’s tax obligations – so called flow-through shares.  

In the UK, investment in AIM market companies attracts a whole suite of tax incentives, and in particular individual investors’ investment in AIM quoted companies does not attract capital gains tax.

We need to start undoing the damage that institutionalising our market – through the exclusion of diverse, smaller investors – has done. 

Individual investors need to be able to access the tax incentives that they are due, by themselves, without being compelled to pay an institution a fund management fee for the privilege. 

We need to take this one step further by also providing direct incentives to retail investors to participate in primary capital-raising by companies outside the institutional investable universe.  

Without positive action to undo 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 effective venue for primary capital raising; and the JSE will soon host a maximum of only those 140 or so companies deemed investable by the 11 dominant asset managers. BM/DM