Equities market at the crossroads - down hill or full steam ahead?

Friday 7th September 2001

The New Zealand sharemarket has attracted favourable recent commentary for doing a bit better than many foreign counterparts, although a rash of merger and takeover activity has introduced a probably temporary element of artificiality to this behaviour.

Sooner or later on-market corporate activity will wind down as targets for ownership change are mopped up. We could then find ourselves stuck with a preponderance of listed leftovers and remaindered stocks.

The extent of present buy-out activity will have bearing on both the range of selection remaining for investment choice and the weightings given the local market in international portfolios. Changes to the takeovers code will also over time reduce likely company bids.

We could be going through a passing phase of permanent change in the nature of the local equities market.

Companies taken over usually disappear from listings and others such as Baycorp are in the process of shifting headquarters elsewhere as New Zealand becomes even more of a branch office economy. In the end a shrinking pool of companies is left that has to justify its existence through respectable return on capital.

Arguably the mergers and takeovers we have seen are a sign that value has been found that was not always reflected in past share price performance and that Kiwi investors will find themselves locked out of this perceived value in future. Confidence in our local sharemarket is hardly boosted as a result.

The gutting of the local sharemarket does not mean that its disappearance is inevitable. There will always be companies that find their primary listing is best kept here, such as those firms operating in New Zealand agribusiness, but many outfits will shift their centre of gravity to where they do most business.

As renewed attention to the fate of the Fletcher Challenge empire indicates, the days of a Kiwi company trying to take over world markets from a New Zealand base are probably numbered.

Even an enterprise like Fonterra could well end up dismembered or in foreign hands if shareholding rules permitted.

Consolidation of local listings is being matched by a trend of mergers, takeovers and overseas relocations by brokers themselves. In a transaction-based business, such as sharebroking largely remains, a dwindling range of stocks and falling local turnover will encourage continued industry restructuring.

Brokers may have to diversify their activities into areas like financial planning and investment advising, which for some would represent a major cultural shift.

My analysis of share portfolios indicates much advice by sharebrokers has been of the transaction-driven type. Often it is difficult from the face of the portfolio itself to find an overall rationale about why a given investor has a particular range and quantity of stocks and industrial sectors.

Further investigation usually reveals the shares were bought piecemeal over time on the basis of intermittent broker recommendation and irregular availability of investment funds.

The result can be a share portfolio that is a magpie's nest. There may be little evidence of suitability to the investor's own risk profile or longer-term goals and needs.

A more systematic approach to investment portfolio creation and management is likely to develop as brokers seek to add value to client relationships and pursue additional sources of revenue. Greater use by brokers of modern portfolio theory, asset allocation, and managed funds is one likely development in this process, along with appointing more staff from managed funds and financial planning backgrounds.

The distinction between direct and indirect investments is more likely to become blurred in client portfolios as both types are blended together.

Another trend likely to accelerate is the appearance of more transtasman share funds, with New Zealand stocks as the minority holding in a portfolio dominated by Australian listings. Such funds reflect the increasing interdependence of the CER economies and that the one-market approach will become a reality for many companies in their own lines of business.

New Zealand listings may suffer from this one-market status in managed fund portfolios because many of them are not as liquid as Australian stocks.

This would cause them to receive a lesser proportion of investment allocation by the funds concerned.

Other consequences of relevance to the number of local listings could arise from seismic international trade events such as China's entry into the WTO. Some local listings might find their businesses cannot compete with Chinese labour costs.

New Zealand will not be alone in feeling the impact of China's increased involvement in free trade, but it has a thinner sharemarket than many countries with which to absorb the shock.

On the other hand, there may be some listings that benefit from greater access to the mainland Chinese markets.

There can be little doubt our equities market is at a cross-roads for a range of reasons over which there is little control within the local investment industry.

The NZSE's responses in demutualisation and opening an office in Auckland will need to be backed by an effective marketing campaign that will keep alive the longer-term prospects for New Zealand to retain some relevance as a capital market within the emerging new global economic order.

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