Market Domination Of Large Listed Firms A Worrying Sign

Foreword from ShareInvestor

This article “Market Domination Of Large Listed Firms A Worrying Sign” by R. SIVANITHY was first published in The StraitsTimes on 19 Mar 2018 and is reproduced in this blog in its entirety.

The Singapore Exchange (SGX) recently reported that the average value of securities traded in February was $1.7 billion, up 22 per cent from last year and the highest since May 2013. This is welcome news, especially to the broking industry which anecdotally, requires daily turnover of around $1 billion to break even. It might therefore be tempting to conclude that the local stock market is in good shape – certainly better than it was a year ago, at least.

Yet one suspects that if volume is broken down to show which stocks have had the largest gains in liquidity, the data would reveal a concentration in the 30 Straits Times Index (STI) constituents, and only a marginal improvement in the rest of the market.

According to most ballpark estimates, two-thirds or 70 per cent of dollar value turnover every day comes from STI stocks. This has been the case of several years now and it means that about 750 companies, or about 94 per cent of listed entities, contribute only 30-35 per cent of daily business. Even within the STI, those who track daily trading would know that the bulk of dollar activity is concentrated in counters such as Singtel, the three banks, Genting Singapore, Thai Beverage, property stocks and the Jardine group.

This narrowing focus is, however, not unique to Singapore and is likely to be found in every market, one major reason being the exponential growth in the exchange traded funds (ETFs) industry. As of end-October last year, the value of ETF assets under management globally was US$4.6 trillion (S$6 trillion) versus just US$417 billion in 2005, a more than tenfold increase in 12 years.

The reasons for this growth are well-known – the shift to self-directed retirement saving, leading to greater demand for passive investment products, the low-interest rate environment over the past decade and technological developments in digital distribution.

Another reason for the heavy concentration in index stocks is that these are viewed as being where the quality lies because much of the quality elsewhere has been eroded by privatisations and delistings. Market players here have long complained about the exodus of well-known names from the SGX (for example Osim, Tiger Airways, Eu Yan Sang, SMRT, NOL) but then the same phenomenon is to be found elsewhere.

For example, in their “Is the American Public Corporation in Trouble?”, published in the Journal of Economic Perspectives, Summer 2017, authors Kathleen Kahle and Rene Stulz reported that the number of US-listed firms in 2015 was 3,766 – about half the 7,500 listed in 1997 and 20 per cent lower than 40 years ago in 1975.

Given that the US economy has grown rapidly over these periods, one would have expected a rise in listed companies but this has not been the case. Instead, the numbers have fallen sharply, largely through fewer IPOs on one side versus on the other side, takeovers by competitors, buyouts by private equity, bankruptcies and privatisations because owners decided that the costs of remaining listed outweigh the benefits.

Significantly, the authors also looked at size, and found that while listed firms are larger today than 40 years ago in terms of market capitalisation there is a heavier concentration in larger firms. “These patterns have given rise to concerns about whether markets have become less receptive to small firms,” said Kahle and Stulz.

The corollary, of course, is that markets have become more receptive to larger firms.

Market concentration is not only increasing in equities but also bonds. Schroders in its February Talking Point “How Can Investors Find Sustainable Income?” said that among US investment-grade bonds, sector concentration abounds – investors who want a yield of 3.5 per cent or higher are forced into buying commodities and subordinated financial debt.

“The dependence of investors on an ever-decreasing pool of higher-yielding securities comes at a time when corporate fundamentals are beginning to look vulnerable. While most corporate borrowers can cover their interest payments relatively comfortably, the total stock of debt outstanding has been growing for a number of years. This means that the market may be vulnerable to even small moves in either global interest rates or central bank liquidity,” the Schroders report noted.

The fund managers also reported a rising concentration in dividend-paying stocks – 50 per cent of the market value of the MSCI Europe High Dividend Yield Index is accounted for by its top 10 constituents.

“This degree of concentration is also apparent from a sector perspective, with a fifth of the yield of the global MSCI High Dividend Yield Index coming from financials alone. Worryingly, as we saw with credit, the key contributors are again financials and commodity-related. This means that investors may be unwittingly concentrating their exposures in the same areas on both the equity and the credit side.”

Market concentration can also be found in everyday life. Consider the emergence of dominant players like Amazon in the retail sector, Facebook in social media and Google and Apple in technology and communications. Traditional economic theory tells us that fewer players or less competition should lead to higher prices but, fortunately for now at least, these big players are intent on carving out greater market share and scale by undercutting their competitors. The $64,000 question of course, is for how long?

In his “Market concentration helping upend conventional wisdom” published in Business Times on Jan 23, MFS’ Erik Weisman stated that the worry with marginalising small companies is that innovation suffers. “Small firms have traditionally been a significant source of dynamism, creating new technologies and building new products consumers don’t even know they want… But today, only the largest, most mature companies have the resources to deal with increasingly complex and costly government regulations. And if the world continues along the path of economic nationalism, the bar will get even higher. This dynamic is helping to squeeze out smaller firms, resulting in less vitality and ultimately less innovation”.

As far as the Singapore stock market is concerned, the effects of higher concentration are very evident – research coverage of smaller firms is declining alarmingly as brokers direct their resources towards the small pool of larger companies; the universe of investible entities available to retail investors is shrinking and, with liquidity and research coverage more likely to gravitate towards larger stocks, the incentive for the smaller ones to remain listed diminishes.

Meanwhile, volatility has risen – concerted selling or buying of only a handful of index stocks (most notably the banks, Singtel and the Jardine stable) leads to large swings in the STI, giving the likely mistaken impression that the entire market has risen or fallen sharply.

Increased concentration may, arguably, be accepted as a natural consequence of market evolution but its benefits are at best debatable.