Last Tuesday, I wrote a short piece on the disappointing status of New Zealand’s capital markets, and particularly how the Financial Markets Authority (FMA) and the New Zealand Stock Exchange (NZX) could make changes to improve them.
Then, less than 48 hours later, the FMA and NZX invited the public for feedback on the capital markets and any recommendations on how they could improve them.
In any case, I’ve taken the opportunity to flesh out my thoughts for them. I’d also encourage you, no matter your experience level, to offer your input. Maybe you’re an experienced AFA with specific technical issues. Or maybe you’re a business owner who is considering listing. Or maybe you tried investing once and found it confusing.
It would all be helpful for the folks over at the NZX and FMA in shaping how Kiwis invest going forward. You can read up on it and send in your feedback by clicking this link.
And below, you’ll find my submittal: my observations and recommendations for a more vibrant investment ecosystem here in New Zealand.
Capital markets feedback
What has been working well
It’s true — the NZX has been a fountain of wealth in the past decade. Kiwis who missed out on stocks, especially those who chose to put it into property instead, must be kicking themselves.
Now you ask for examples of ‘specific initiatives’ that helped fuel that remarkable period…and I’d contend that nothing mattered more than examples of success like Xero. That story showed businesses the potential for growth that can come through listing…and it proved to investors the opportunity for immense returns.
However, this also represents a double-edged sword…as Xero’s departure from the NZX also demonstrated the capacity for growth that can come from overseas markets. Investors and business owners noticed that too.
The goal, in my view, should be to highlight those success stories as often as possible…and illustrating how investors and businesses could replicate them.
Recommendation: document and promote how capital market growth compares to other investments. Everyone should know, for example, that they could have made 500%+ returns from the NZX50 between 2003 and today. That’s incredible…and should be shouted from the rooftops.
NZ as a SME economy and funding gaps
New Zealand’s small and medium-sized companies don’t much care for the local capital markets. That can be seen through the IPO drought, the low company count on the NZX, and the regular headline of some Kiwi wonder-company moving across the Tasman or the Pacific.
It’s not that there’s a lack of capital to distribute. There’s plenty of wealth to flow into business. The problem is connecting the wealth-holders with the wealth-needers…and facilitating that relationship in a mutually advantageous way.
Sadly, I fear that high costs severely undermine growth at the small end of the market…with small-cap companies paying proportionately high fees to list and retail investors paying high fees to invest.
It’s natural, then, that private equity or overseas investment tends to fill that gap.
And notice that it’s the private sector stepping up to fuel entrepreneurial growth in New Zealand, not the public sector. Perhaps a growth fund like those seen in the UK and now Australia could benefit this overlooked sector. But, historically, state initiatives like this often run inefficiently and inject bureaucracy into what should otherwise be a nimble, agile environment.
Recommendation: reform cost structures for businesses under $100 million in capitalisation or potential capitalisation. Look at private equity channels for insights into what’s working. Simplify initialisation processes for both new businesses interested in capital as well as new competition on the brokerage side.
Limited number of new listings
The IPO drought reflects the NZX platform, not the entrepreneurial growth in New Zealand…because we can easily see that New Zealand is generating heaps of growing businesses and innovative ideas.
The problem is attracting those innovators to the public equity market.
There’s a marketing side to that issue, which Brian Gaynor outlines here.
But I believe a more significant problem is the lack of investment flowing to the small end of the market.
Imagine you’re a small company thinking about listing. You know, from the get-go, that none of the major funds or wealth managers will pay much attention to you. If you’re too small, you’re under the radar. This can be observed with the significantly low liquidity in the bottom third of the NZX by capitalisation.
The solution, I believe, will come from attracting investors to the small-cap sector. Greater investment for small companies makes listing more attractive. More listings compound the potential for returns, encouraging more investors to enter the market. An upward spiral.
Recommendation: to revive the flow of new life into the public equity market, initiatives should attract and incentivise investors to look towards the lower-capitalisation stocks. Then the successes and investment growth should be heavily marketed to potential listers.
Retail investor participation in NZ capital markets
The significant lack of retail investors in the New Zealand equity markets can be blamed on three main factors:
- High trading costs. Low competition amongst brokers has created a high fee environment for investors. High fees hurt returns. Low returns discourage investment…and push investors towards other vessels like property or towards passive index funds.
- Lack of advice. It’s hard to find good advice in New Zealand, particularly independent advice. Most of the helpful financial analysis is reserved for high net wealth clients or sourced from providers with potential conflicts of interest.
- Complicated processes. Buying stocks and checking up on your portfolio should be easy. Most local platforms today are poorly designed or are too expensive for your average investor. Understanding tax implications adds to the mess with PIR, FIF, imputation, and other matters to navigate.
Recommendation: decipher why broker costs are high and focus on lowering them. Ease the entry and oversight processes for new competition in the financial advice sector. Promote better user experience across platforms, potentially offering incentives like data sources to do so. Reform the tax structure…or at least focus on clarifying and educating on how it works.
KiwiSaver perhaps represents your greatest tool in rekindling this market.
But with passive fund management and low returns across the board (negative real returns in all categories in 2018), it seems to be underutilised.
The easy solution is to offer self-managed solutions. Let savers drive how their money is allocated, beyond the nebulous categories of ‘conservative’ or ‘growth’. Specific companies. Specific sectors. It would likely mean a huge influx into the small-cap market, which would check quite a few of your boxes.
But that would have to be paired with better advice and lower fees, if returns are to be the main incentive for self-managed activity.
Recommendation: consider ways that KiwiSaver members can take more control over how their money is moved around. Couple that with more advice and lower fees.
Regulation and compliance will almost always be the greatest enemies of growth. They represent dollars and hours that are non-productive and costly.
But that’s not to say that there shouldn’t be regulation. Of course, there must be. Businesses and investors have to be protected.
The goal should be to minimise the regulatory and compliance costs that businesses face, while maintaining an efficient structure of protection. To save costs in terms of both time and money, processes should be simplified.
Again, I think the private equity markets may provide good examples of how this can be done. Their structures often require a focus on eliminating unnecessary documentation and costs, even at a granular level. The size of the start-ups in their system demands it.
Recommendation: look to the private equity or venture capital organisations for examples of how cost-efficiency can be achieved. Interview executives of companies that chose those platforms over others…and uncover the practical reasons they made that decision.
NZ’s Capital Markets in 10 years’ time?
There are two trends that I see as shaping the capital markets over the next decade: the application of technology to simplify processes and the rise of robo-advice. Both are already here…and I think that the capital markets of 2029 will consist of the players that adopt those trends today.
It’s a fast-moving and competitive world, with no room for laggards.
While these opportunities will improve efficiency and effectiveness, they also introduce new risks as they evolve. Data leaks, bad advice, misallocation of funds, hacking, bugs, viruses…these risks are also showing up with full force. A strong emphasis on staying ahead of those factors will be key to a decade of growth.
Practically, I think we’ll see a significant development towards ease-of-use, which will remove obstacles for new investors and businesses. User-friendly apps for investing. Plain-English financial advice. Less raw data and more useful insights. AI-based guidance. It may even mean a gradual consolidation of the various capital markets into a single, simple interface.
Theoretically, it should open doors for a huge untapped market of investors and businesses, injecting growth and new wealth throughout the country.
Recommendation: embrace technology and make it a core element of every single initiative. Focus on ease-of-use. Invest in teams to combat the new risks that technology brings.
Feedback for NZX and FMA as regulators and promoters of NZ’s Capital Markets and their growth
The NZX is a wonderful asset to New Zealand’s economy, and the FMA guarantees its trustworthiness. Together, both organisations will fuel more growth in this nation over the next 10 years than we’ve experienced in the past 50.
Kiwi investors and businesses would both benefit from participating in this movement.
And to attract those investors and businesses, both the NZX and FMA must continually welcome what Joseph Schumpeter called ‘creative destruction’…putting away the old to make room for the new.
But it’s hard to do that, especially in large organisations. For the people who built the old systems are now in charge of incorporating the new…and its natural to see the value in what you created and the problems in what others create.
But this phenomenon — being married to certain ideas — can become a ball-and-chain in your journey to evolve. You risk getting stuck in the past.
Personally, I have faith in the NZX and FMA to evolve and provide continually improving services to its clients and members…this invitation for feedback is a testament to that. I eagerly look forward to participating in the new capital markets that you form…and helping other Kiwis join in too.
Recommendation: enforce internal structures that encourage criticism and make room for new ideas. Avoid conflicts of interest between the decision-makers who may have built the legacy protocols and those tasked with introducing change. Keep up the good work in listening to your customers.
Based on your preliminary observations, it appears you already have a good understanding of the misalignments in taxes…so I won’t add much. Only that simplicity and lower tax costs benefit those target markets you’ll need to successfully grow: small businesses and retail investors.
To rekindle markets, you need a spark — an incentive — to make it happen. Perhaps a reformed tax structure could be that spark.
I will add that FIF and PIR remain thorns in the side of retail investing here in New Zealand. It’s unclear and non-intuitive. It’s not hard to imagine how they might dissuade new investors from getting involved.
Recommendation: seek lower costs for new entrants into the market: both investors and businesses. Remove obstacles for scaling by simplifying structures. Aim to promote IPOs in all reforms.
Most of my opinions above have been shaped through the hundreds of letters sent in by you and thousands of your fellow Money Morning New Zealand readers.
I greatly appreciate hearing from you and getting your unique insight into how the world of money works. If you’ve read my feedback above and would like to correct me or add to an idea, please feel free to reach out. I’m just a traveller trying to navigate these financial waters…and I can use all the help I can get. I can be reach through email@example.com
I hope that others contribute their thoughts to the NZX, FMA, and the Steering Committee…so we can experience more vibrant capital markets in the near future.
Editor, Money Morning New Zealand