Inside the ‘structural constraints’ of the BSE

Inside the ‘structural constraints’ of the BSE

During the initial global crash influenced by COVID 19, the BSE remained resilient but declined when other markets recovered. 

Stock markets around the world suffered a major crash in the immediate aftermath of the COVID-19 pandemic. At the time, economic think tank, Econsult says there were fears that the collapse would continue for a prolonged period with no clear indication of when it would “bottom out”. 

However, there has been a strong recovery in global stock markets following the initial shock, especially during the second half of 2020. In fact, over the course of the 2020, the MSCI World Index and the MSCI Emerging markets Index grew by 14.1 percent and 15.8 percent respectively when compared to 2019, Econsult says. The BSE however suffered an almost perfectly opposite fate, during the initial global crash, the Domestic Company Index (DCI) remained stable but failed to register any significant growth during H2 2020. 

The DCI declined by 8.2 percent in 2020 which the BSE says mirrors the anticipated decline of 8.9 percent in the national economy in 2020. Howevers, analysts at Ninety One released a report recently claiming that the expected decline of the economy was just an exaggeration and that the economy will only decline by 6 percent. This being boosted by the improvement of diamond sales which after many talks of diversification still remain the mainstay of the economy. 

Tshegofatso Tlhong, the Portfolio Manager at Kgori Capital explains that the BSE is a relatively shallow market. She says the investment universe does not fully capture the full spectrum of the economy; this limits the options investors have and therefore they cannot fully express investment ideas like in more developed markets. “Furthermore the depth of market participants is skewed to long-term institutional holders who generally invest through the cycle versus retail investors who trade frequently and are therefore drivers of price discovery,” Tlhong says.

Retail investors’ interest in the market has certainly piqued since Choppies listed. This was further cemented when BTCL listed as their widespread roadshows sensitised a lot of people regarding the stock market and how it can be used to build wealth. But institutional investors are key investors, mostly holding assets on behalf of the BPOPF, the country’s largest pension funds. 

Pension funds are long term in nature and holding shares as assets matches the future liability (paying a pensioner in the future). Where holdings are concentrated in the hands of a few, it is believed there are challenges on all the three fronts; tightness (bid-ask spread), depth (quantity required for a traded volume to change the price and resilience (ability of prices to revert to normal after a shock).

Experts say there will be a wide bid-ask spread as the shares will not trade frequently (since only a few investors control the shares). Where these investors sell, the price will be prone to wide movements on either side as there is not enough depth in the market to absorb the shares. Finally, it’s unlikely that the price will revert to equilibrium after such a shift. To improve liquidity, experts say retail investors ought to be taught about the market so that their participation can improve, although the medicine is not being to curtail participation of pension funds in the market. Others argue that during IPOs, companies should do an aggressive road show to entice international investors. 

“These structural constraints therefore mean that the BSE listed company prices will not move like in markets where there is greater market breadth and depth,” Tlhong says. Tapologo Motshubi, Portfolio Manager at Allan Gray adds; “investors have very limited options relative to developed markets and hence choose not to trade as actively. This can serve to reduce the volatility of securities prices”.

For equity funds, selling one stock should be so that another stock can be bought. If there are no better stocks being offered, managers are likely to hold to what they have which means the prices remain unchanged. Pension funds are long term in nature and holding shares as assets matches the future liability (paying a pensioner in the future). 

The BSE says disposition has been to consistently explore ways of improving the resilience of the domestic capital market. “We aggressively promoted the listings value proposition and it has been heart-warming to note the appetite by several companies to list in the short to medium term,” the bourse says adding that “the pandemic has challenged most unlisted companies to restructure and look for avenues of sustainable long term capital, being the stock exchange, which is very important in pandemics such as this that negatively affect solvency and access to traditional finance”.