Can more research inject life into SGX?

There is little money for quality research but stock exchanges are keen to turn things around and fintech may help

The FTSE ST Catalist Index is up 16 per cent since the start of the year, better than the 9.8 per cent rise from the Straits Times Index. But how many people realise this?

The fact remains that Singapore's small- and mid-cap universe is not easy to love. Certain stocks still go for days without seeing a single trade on the Singapore Exchange (SGX). Not because they are suspended, but because they are forgotten by investors.

The problem could lie with the lack of good quality research on stocks. The argument is that prices are a function of good-quality information. If there is little or poor information, investors stop trading in the stocks and liquidity dries up. This is especially so for small- and mid-cap stocks. Fewer than 70 stocks on the SGX have a market cap of more than $2 billion and institutional interest tapers off quickly if liquidity or market capitalisation drops.

There are market players who do not rely on research when they trade, while others observe that the lack of analysis is due to the dearth of good stocks rather than any other factor.

But research budgets and sell-side analyst numbers have shrunk so fast under the legacy left by the 2008 financial meltdown that one wonders if the collateral damage might be larger than expected.

It does not help that two broad trends are set to aggravate the situation.

First, funds and investors have become more globalised, which means their home bias - investors tend to invest in their home stock market - is becoming less strong.

This also means that they are less likely to look at second-tier stocks. Why would you invest in a small-time Foxconn supplier when you could just as easily invest in Foxconn directly?

Second, the rising popularity of exchange-traded funds and passive index investing has exacerbated the lack of attention suffered by small-caps. Even some so-called active fund managers have given up on stock-picking, earning the sobriquet of "benchmark huggers" or "closet indexers".

When lazy money follows an index, stocks that do not make the team easily fall off the radar.

Earlier this month, SGX head of equities and fixed income Chew Sutat addressed a gathering of small-cap enthusiasts and media at an event organised by fund manager Azure Capital.

"They say London is a very big market, but if you are not in the FTSE 100, you share only the balance 15 per cent of market liquidity," he said.

Likewise in Australia and Thailand. Stocks that do not make it into the benchmark ASX 200 or SET 50 share only less than 10 per cent of the market liquidity.

A strong argument can be made for the role of high-quality equity research in a vibrant stock market.

That is the SGX's view. It is encouraging more research, and it is not alone. The Australian Securities Exchange and Malaysia are funding research reports for lesser-known stocks.

In fact, the SGX has long taken the position that more research is key, although earlier initiatives have faltered. The SGX-MAS Research Incentive Scheme, which started in 2003, languished amid a conflict of interest hullabaloo after issuers or companies argued that they could not possibly be expected to pay for "sell" calls.

Then there was the SGX Equity Research Insights scheme, which addressed this grievance but struggled for relevance when most participating companies opted for non-rated analysis. This meant that the analysts did not come up with a buy, sell or hold call, recommendations that investors would find useful.

SGX is having another go at promoting issuer-sponsored research, in which the company or issuer pays for a research house to initiate coverage. So far, about 10 issuers and three research houses have made use of the new SGX StockFacts Research Programme launched late last year.

The jury is still out as to how successful it will be in drumming up investor interest. Once again, analysts are not required to tag a rating to their reports.

But this does at least mark a considered effort from a market operator to play a more active matchmaker role between issuers and research houses, especially in this challenging research environment.

And there could be more shocks on the horizon. One development that will almost certainly lead to a decline in the amount of research and stock information available to retail investors is the upcoming introduction of an international piece of financial reform called MiFID II (The Markets in Financial Instruments Directive).

From next year, fund managers in the European Union will be required to tell investors exactly how much they pay banks and brokers for external research, meant to create greater fee transparency and protect consumers from product-churning.

Research fees will not be linked to trading commissions any longer.

As smaller companies offer less in terms of corporate finance business as well, many expect coverage of small- and mid-cap stocks to decline further as the regulatory change filters through to the industry here eventually.


The SGX is not alone in its endeavours to build up Singapore's research ecosystem.

In fact, the staid, mature landscape of equity research makes it ripe for fintech innovation.

Mr Raghav Kapoor, chief executive of Smartkarma, a subscription-based marketplace for research, remarked that the last innovation that happened in research was in 1993 - when the portable document format (PDF) was invented.

For independents like him, the crisis in the industry, the explosion of data and the tailwind of MiFID II create the perfect opportunity to redefine and rebuild research.

"The medium has to evolve," he said. For example, Smartkarma has designed a stock "discovery" tool which crunches data to tell analysts on its platform which companies are of the most interest to users but have the least number of research reports published. Researchers can then respond to that.

It is early days yet, and more can be done to create new analysis tools and workflow tools for investors and analysts alike.

In the meantime, paid research is still better than no research. London-based Edison Investment Research, a large purveyor of issuer-sponsored research, has argued that the so-called conflict of interest in its model is no different from an issuer paying a credit rating agency to rate its bonds or an auditor to sign off on its accounts.

"Both rating agencies and auditors have their own reputations to think of and being credible matters," it said in a 2014 white paper.

NRA Capital head of research Liu Jinshu said a well-written research report carries more than a rating. He added: "I qualify my 'overweight' calls by placing companies along a return and risk matrix when appropriate. This way, readers are aware of the risk I am proposing in exchange for the expected return."

One would also hope that paid research is kept a niche market involving as few players as possible, to prevent "opinion-shopping" by issuers.

And even as there is a good case for having more research, the SGX must continue to be tough on regulatory surveillance.

That's partly because counters with very small market capitalisation are more prone to stock manipulation. So while the SGX continues to whip up interest in the neglected firms, it also needs to maintain vigilance on the regulatory front. Otherwise it risks criticism and complaints if any of the firms collapses.

But we should not get too caught up with the idea of research reports themselves.

A well-received effort by the SGX in 2014 was the launch of StockFacts, a free stock-screening tool for retail investors which, in a unique move by an exchange, is paid for by the bourse itself.

In other words, what counts as useful research need not fit the traditional template of a three-page report. Any efforts that improve access to high-quality useful information can only be positive for investors.

26 April 2017


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