The future of the stock market

In 2018, Hank Bessembinder, professor of business at Arizona State University, published a paper in the Journal of Financial Economics with the rather nonsensical question: Do stocks outperform Treasury bills? It seems nonsensical because, in the period from 1926 to 2016, the approximately 25300 companies listed on US stock exchanges, created $35 trillion in net wealth for its shareholders, in other words, $35 trillion more than what investors would have earned on US Treasury bills. But here is the catch: all of that net wealth was created by the top 1092 companies – or 4% of the total. In other words, the remaining 96% of listed companies ‘collectively generated lifetime dollar gains that matched gains on one-month Treasury bills’.

One might easily conclude from this research that it is vitally important to pick the right stock. But that is almost certainly the wrong conclusion. Bessembinder explains: ‘The results presented here reinforce the importance of portfolio diversification. Not only does diversification reduce the variance of portfolio returns, but also non-diversified stock portfolios are subject to the risk that they will fail to include the relatively few stocks that, ex post, generate large cumulative return.’

And this is exactly why public capital markets have been such vital tools for the democratisation of wealth. Imagine if those 1092 companies had remained in private hands. The massive gains would have accrued to the lucky few who would have been founders and early investors. The result would have been extreme inequality.

Yet this is exactly what many fears may be happening today. The technological revolution of the last three decades has changed the nature and scale of start-ups. Many firms in the tech space, for example, do not have the capital requirements of the brick-and-mortar companies of yesteryear, allowing them to remain private for longer, and raising concerns about rising inequality and exclusion. I asked Dr Leila Fourie, Group CEO of the Johannesburg Stock Exchange, what the JSE can do to counteract these changes and bring more firms to a larger audience of investors.

‘There are two components to this. The first is to have global corporations list in the South African market. In order to attract international companies with favourable growth prospects – tech focused or other – the South African market must be attractive to foreign issuers. Our capital markets are both deep and liquid making it a favourable destination for issuers wanting to raise capital in Africa. The JSE also has a large institutional base which is attractive to issuers of both debt and equity.

‘Some of our local companies also offer exposure to high-growth industries. Naspers is an example of an SA-listed stock with exposure to one of Asia’s fastest growing tech stocks. We would like to welcome many more such listings to the exchange in future. One of many initiatives aimed at driving listings is our recently approved standard listings which are LSE-listed companies which are subject to less stringent listings requirements.

‘The second approach is to have local high-growth companies list on the JSE. In order to provide local investors with a wide range of investment opportunities, there needs to be a strong pipeline of local businesses maturing to the IPO phase. Current macroeconomic challenges and the cyclicality between debt and equity mean that IPO’s have been low across the globe.’

But this is not just a cyclical trend. Over the last two decades, the number of firms listed on the JSE has declined substantially. The good news is that plans are being made to reverse this decline. ‘We are not resting on our laurels. Indeed, the JSE is exploring avenues to support SME’s in South Africa while also reviewing the listings requirements for small and mid-cap listings’’, says Fourie.

Democratising wealth does not only mean adding more listed firms. It also involves attracting more investors to the market. I ask Fourie about the benefits and challenges of retail investing, a trend that has accelerated rapidly since the arrival of Covid-19.

‘The JSE recognises the growing retail investor market and their need for a healthy, trustworthy and thriving ecosystem that allows them seamless access to the financial markets. We agree that it has been difficult in the past for individuals to invest directly on the stock market – the JSE’s value chain has been better geared for institutional investors. This is something we are determined to address, not in competition with our members, but rather together with the rest of the financial market ecosystem. Each party in this value chain plays a valuable role, and we believe that together we can increase access for current retail investors, and also grow the market in totality.’

Another approach to deepen the capital market is to entice international investors to South Africa. Are there any specific plans to do this? ‘The JSE’S collaboration with China Investment Information Services is an exciting first step in our Asian growth journey. Investors in Asia with an interest in South Africa will require reliable access to JSE market data as a precursor to any trading activity. With JSE market data now available, we can start to turn our attention to how we build interest in the JSE as a trading destination.’

Bessembinder’s research has not been replicated for historic JSE-listed companies, but there is little reason to suspect that the results will look very different. Although the JSE has traditionally yielded higher returns than most other equity markets, it seems probable that a small set of firms have been responsible for most of its net wealth creation.

Yet this trend, too, may be changing. As more companies – notably the more successful ones – list on multiple exchanges, and new technologies allow retail investors access to the most valuable companies, one can expect the democratisation of wealth to expand. But this will only happen as long as public capital markets like the JSE remain attractive intermediaries matching those with capital to those in need of it.

*An edited version of this was first published in Finweek on 23 April. Image source: Top Women.