The Research Market in New Zealand: Debt and Equity

Summary and discussion of The Research Market in New Zealand: Equity and Debt¹

The Capital Market Development Taskforce commissioned Esperance Capital to investigate analyst research on securities issuers in New Zealand. Although broker analyst research in New Zealand is generally considered to be of a high standard and quoted companies are covered where it is commercially viable to do so, there may be a case for other market participants, and potentially government, to fund additional analyst research on a non-commercial basis.

Esperance Capital's report describes the research currently undertaken, the needs of investors and issuers, and the way that investors and issuers promote this research. The report also considers the pros and cons of specific models for funding and delivering additional research.

Analyst research in New Zealand, and the case for treating it as a "public good"

A number of academic studies over the past twenty years have found that analyst coverage improves a stock's liquidity and raises prices. Accordingly, the creation of analyst research and its distribution to investors brings benefits to society. Companies covered by analysts benefit from a lower cost of capital. Current and potential investors in a stock benefit from greater liquidity and more efficient pricing.

However, although it costs almost nothing to distribute research, creating research is costly. In a normal securities market, brokers' analysts deem it rational to cover only a minority of companies, and access to research is typically restricted. A company generally needs to have annual exchange turnover of over $20 million to justify coverage by a broker, who distributes research in an effort to generate orders. INFINZ data show that six major New Zealand brokerages cover 30 stocks, and a further 37 are covered by some of those firms.² There are 47 (41%) NZ Exchange companies without any analyst coverage at all, and a further 15 have only one or two analysts covering them. There is generally no coverage of small stocks³, and no coverage of the companies on the smaller exchanges, the NZAX or Unlisted.

Low analyst coverage of small quoted firms is a problem not just confined to New Zealand. Studies in the United States and Australia find similar results.

There could be a case for stimulating additional analyst research on securities, aimed at creating more informed, liquid, and efficient securities markets. There are likely to be social benefits from this research – such as a lower cost of capital, and more efficient investment decisions – that go beyond the private benefits to brokers and their clients.

Key questions are:

• Are there other private firms that already provide the public benefits identified above?
• If not, what is the best way for government to encourage research, and would the benefits exceed the costs?

Alternative research models

There have been numerous efforts to offer independent research in other countries, and both governments and the private sector have grappled with the issue of extending coverage to smaller stocks. Specialised commercial players have sought to offer research paid for by either issuers or subscribing investors. To date, similar efforts in New Zealand have not been particularly successful in extending coverage to small quoted companies. Market operators and industry bodies overseas have also experimented with creating institutions to perform research, or to contract existing brokers to cover smaller firms. Funding of these has tended to come from issuers and market operators, with governments also making a contribution in some cases.

Commercial models

Issuer-funded commercial operator

Overseas there are examples of issuer-funded commercial equity analysts, a model akin to credit rating agencies. For example, Edison Investment Research in the UK covers 474 issuers (though not all are actively covered at one time) and employs 29 analysts and 5 research support staff. Their research is distributed free to institutional and wealthy investors. However, nothing like this has worked well in New Zealand. Those interviewed for this report suggest the following are key reasons:

• There is general distrust of issuer-funded research because of the potential for conflicts of interest. It is difficult and costly to build up the reputation for independence established by Edison.
• The New Zealand market is too small for this to be commercially viable. In particular, there are too few stocks and fund managers.

Investor subscription-funded commercial operator

Commercial analyst companies, such as Aegis in Australia and Morningstar, provide research on a paid subscription basis. Some large dual-listed New Zealand stocks are covered by Aegis.

This is not done on any scale in New Zealand. It is more common for subscription services to aggregate broker research or provide newsletters and tips than to generate broker-quality research of their own.

Non-commercial models

Non-commercial analyst coverage of small quoted companies can be organised in a variety of structures to maximise independence, quality, and cost effectiveness. There are also several potential funding sources for this research.

Funding options

Potential sources of funding are:

• Issuers. Issuer contributions are a feature of Australian stock exchange/Finsia's research scheme, as well as Singapore's Research Incentive Scheme. Interviewees suggested that New Zealand issuers would be unlikely to make any contribution to analyst research, because of the high cost of maintaining listings. This is questionable, given the benefits to issuers of coverage. In many countries attracting coverage is considered an important objective of companies' investor relations functions.
• Market operators. The Singapore Research Incentive Scheme is partly funded by the Singapore stock exchange. Market operators would seem to have a direct interest in improved research coverage given that it is likely to increase trading volumes and fee revenue.
• Levies on investors. A variant of market operator funding, in this model each trade would attract a levy (e.g. $3 per trade). This would be collected, for example, via the NZ Exchange settlement system. Interviewees were generally receptive to this model.
• Government. One source of funding for Singapore's scheme is the Monetary Authority of Singapore's Financial Sector Development Fund. Malaysia's equivalent scheme is partially funded by the Capital Market Development Fund, the board of which is appointed by the Minister of Finance and chaired by the head of the Securities Commission. Interviewees thought a government contribution would be politically difficult. The report suggests that government might focus on funding the institution that allocates research, while the research itself could be funded from other sources.

Allocation of research

Regardless of funding source, the institution that receives that funding will make choices about which companies to cover, and will either employ analysts to carry out research or pay commercial analysts to do it. For the research to be trusted, the allocating institution needs to be independent from those who would benefit from particular recommendations – including issuers and those organising new issues of securities. The allocating institution also needs to be efficient to avoid too much funding being swallowed in administration.

Potential allocators of funding are:

• Market operators. Interviewees said there could be conflicts of interest if a market operator contracted research, although it is unclear what such conflicts might be, or why they could not be adequately managed.
• An independent not-for-profit foundation or industry association. Such an organisation could be set up to perform the allocation role.
• Government. Government already performs this role in some areas, e.g. in science, the Foundation for Research, Science, and Technology contracts to research providers on a contestable basis.

Performance of research

A key decision is whether the allocator of funding should also do the research. Advantages of splitting the two functions are:

• Providers could be brokers and independent analysts. This would take advantage of existing expertise, and these firms have strong incentives to market research to clients.
• Research contracts could be contestable (as in the science system), improving quality and price.
• It would support the development of independent research in New Zealand.

On the other hand, advantages of building capability within the organisation allocating funding are:

• It would be easier to remove or manage conflicts of interest between research providers and the issuers they are covering, or between the research providers' commercial aims and non-commercial analysis.
• The science system has demonstrated that the costs associated with competitive bidding for contracts can be very high.

Depending on who the allocator of research is, there may be additional pros and cons of adopting a split. For example, while government has some experience in monitoring the performance of SOEs (through CCMAU), interviewees worried that research prepared directly by government agencies could become politicised (and therefore lose its independence). Also, government could find it difficult to attract high quality analysts. They also expressed concern about the consequences of government providing advice on investments in private companies.

Marketing and delivery

For analyst research to achieve its objective, it must be disseminated to investors, and enough investors must act on the information they receive. If brokers produce the research, they will be well positioned to disseminate that to their clients as they do currently.

Public websites provide an additional, important channel. The report notes that the research output on the Singapore stock exchange website is poorly presented. A well designed research portal with supporting market pricing data, news and relevant market information (for example, comparisons with market averages) would be the minimum needed.

This site uses cookies to track and analyse usage.