Commentary: Could public sector-backed funds create greater liquidity in Singapore’s equity capital markets?
Amid a strong push to stay ahead of the capital markets technology curve, Singapore’s equity capital markets (ECM) fundamentally require the support of the Monetary Authority of Singapore (MAS), much like how liquidity in Japanese equity markets are underwritten by investments from Japanese pension funds and the Bank of Japan.
Such a move could both enhance the general liquidity of the securities market, sidestepping the political sensitives around the use of pension assets which are invested in markets elsewhere and spurring the growth of the exchange-traded fund (ETF) cluster in Singapore.
Recent developments in Singapore
While the move to boost enterprise financing capabilities in Singapore with an S$75 million scheme is a positive step amid growing competition with regional capital markets, it also does not address the underlying issue of liquidity, as well as deficits in the capital markets media ecosystem; the lack of media visibility often impairs the ability of enterprises that have pursued share sales in Singapore to access liquidity.
In the past, there have been various research schemes, including those paid for by the listed companies themselves, but the use of algorithmic journalism is one solution that could resolve this issue.
Unless the perennial issue of lacklustre liquidity that has affected Singapore’s equity markets in the past few years can be addressed, its equity capital markets risk being marginalised despite its aspirations of being a globally competitive financial centre.
Liquidity matters because it influences the cost of capital for issuers and the cost of trading for investors. The equity markets of other hubs such as New York, Tokyo, Seoul and Sydney are underwritten by extensive pension fund investments, as well as the use of automated trading system, which contribute to the high turnover velocity seen in New York’s capital markets.
But their capital market ecosystems also support a large pool of equity analysts, enabling extensive research coverage. This is coupled with media visibility from an array of media brands, which highlights investment opportunities for both retail and institutional investors across various categories and segments of companies.
While the move is a step in the right direction and a number of industry observers and players suggest that Singapore has a healthy pipeline of listings, more can be done to enhance the capital markets ecosystem.
Since the implementation of dual-class shares on the Singapore Exchange (SGX), issues of shareholder protection and overall liquidity on the bourse are core issues that have been raised in the public discourse. One approach that could mitigate liquidity concerns is for the MAS and other state-linked funds could drawn inspiration from the equity investment strategy of the Bank of Japan.
Singapore’s equity capital market landscape
The Singapore Exchange (SGX) cannot compete with the bourses of large neighbours such as Hong Kong, Tokyo, Sydney, Indonesia, Vietnam or Seoul for primary listings — the small size of Singapore’s domestic economy limits the proliferation of large local enterprises — though it has arguably developed a niche as a bond centre and maintains a robust derivatives marketplace.
While this can be attributed to it being a mature economy at a different stage of its capital markets’ IPO cycle, concerns remain regarding the future of its stock market. Arguably, Singaporean equities urgently needs a boost in investor confidence and liquidity.
With an estimated 40% of listed enterprises on the SGX being foreign, the bourse has a claim to being a center for supporting the efficient allocation of international capital and arguably excels in niches such as property, infrastructure and consumer goods, while also developing competences in technology and healthcare. It also has the largest REIT market in Asia ex-Japan, with extensive business trust listings of shipping, aviation and infrastructure assets.
While the bourses of Hong Kong, Seoul and Tokyo may be deeper and more liquid, they are also highly insular, with investors holding a strong domestic bias. For instance, Hong Kong is an excellent listing destination, but only if a company’s business operations or brand is centred on Greater China.
The bourse has effectively positioned itself at the centre of an east-west nexus, with co-listing agreements forged with the NASDAQ, the Tel Aviv Stock Exchange (TASE) and New Zealand Exchange (NZX). Its surrounding ecosystem — particularly its strong secondary financing capabilities and debt capital markets — has many of the virtues needed to attract high-quality listing across a number of sectors.
As an international financial center with state-linked funds that possess abundant capital, as well as a huge pool of retirement funds, reinforced by a robust resistance to corruption and ease of doing business, Singapore has many of the virtues needed to attract high-quality listings. It is comparable to London in terms of attracting capital investment and is seen as a contender as an international financial hub.
It is home to Temasek Holdings — one of the world’s most experienced technology investors and whose holdings account for significant part of the SGX’s market capitalization — and has the world’s ninth largest pool of pension assets, estimated at US$268.4 billion by the OECD in 2018.
Using information from Willis Towers Watson , Singapore’s government has abundant capital under management. Sovereign wealth fund GIC (US$359 billion), pension fund Central Provident Fund (US$269.1 billion) and state investment firm Temasek Holdings (US$230.3 billion) are ranked among the top 20 global asset managers as of 2018.The Monetary Authority of Singapore (MAS), had total foreign reserves reported at US$398.06 billion as at September 2018. In aggregate, this amounts to US$1.256 trillion in assets under management.
Yet it’s equity capital market is unable to capitalize upon this due to moribund liquidity, coupled with a lack of support from its major institutional investors. With ongoing concerns regarding the future of the Singapore stock market and its ability to remain competitive with global and regional peers, what is notable about Singaporean equities is a lack of financial backing by local institutional investors.
Arguably, it might be time to review this policy and explore injecting capital from state-linked funds and the Central Provident Fund (CPF) into the local stock exchange. At this time, the best comparison is to use the precedent established by the BOJ and explore the use of index-linked mutual funds or ETFs to spur liquidity.
Bank of Japans’ equity investments
The BOJ and Swiss National Bank (SNB) are among the central banks that have aggressively pursued equity investment strategies since the global financial collapse of 2008.
While most central banks decline to purchase equities outright given the risks involved, their actions are credited with supporting major stock markets. In the case of SNB, it has pursued its equity investment strategy since 2015 and grown a substantial stock portfolio with the view to devalue the Swiss franc, in order to enable the Swiss economy to remain competitive.
Meanwhile, since 2010, the BOJ has made investments into exchange-traded funds (ETFs), corporate bonds, foreign mutual funds and real estate securities. Part of of a broader asset-buying scheme to ease monetary conditions, this has also underwritten the liquidity of Japanese equities alongside pension fund investments.
The BOJ allocates capital to index funds that track the Tokyo Stock Price Index (TOPIX), the Nikkei 225 Stock Average, or the JPX-Nikkei Index 400 (JPX-Nikkei 400). This allocation to ETFs enables it to capture either the entire market through investing into a broad index or specific themes.
This purchase of beneficiary interests in index-linked exchange-traded funds (ETFs) and investment equities is motivated by the desire to sustain growth; the BOJ has exhausted stimulus options like interest rate cuts and bond purchases. It has also driven the creation of a dynamic and thriving equity market and constellation of ETFs.
The BOJ executes this by appointing trust banks, which establish a money trust that subsequently purchases ETFs and other investment securities. These are conducted pursuant to standards set by the BOJ and bought at the volume-weighted average price.
According to Sayuri Shirai, a professor of Keio University and a visiting scholar at the Asian Development Bank Institute (ADBI), as well as a former member of the BOJs’ board, the policy to indirectly purchase stocks is unprecedented in terms of the scale and duration among major central banks.
In a working paper for the ABDI, №865, published in August 2018, “ Bank of Japan’s Exchage-Traded Fund Purchases as an unprecedented monetary easing policy”, she observed: “The purpose of this policy is to promote portfolio rebalancing among individuals in addition to achieving the 2% price stability target. While stock prices have more than doubled, individuals have remained largely risk-averse and foreign investors have increasingly dominated the stock market.”
“Moreover, the BOJ has become one of the largest (silent) investors, with growing impacts on stock prices through reducing downside risk and possibly overvaluing some small-cap listed firms.”
“Given that achieving 2% inflation is a distant future prospect, the BOJ may find it necessary to gradually unwind the policy by purchasing ETFs only when the stock market is under severe stress, and thereby reduce the annual pace of ETF purchases from about ¥6 trillion. This view is in line with the BOJ’s adjustments announced in July 2018 on introducing flexibility and changing the composition of ETF purchases.”
However, where the BOJ proceeds in terms of formulating a policy with greater clarity and decisiveness is nebulous. Shirai has argued that its overall effectiveness is questionable, with key issues that include “…stock prices not rising in proportion to profits, the overvaluation of some small-cap stocks, and adverse impacts on corporate governance”.
In the case of Japan’s institutional investors, pension funds require diversified portfolios because bonds and equities will not generate sufficiently stable, long-term income to meet liabilities as the population ages. Long-dated assets — such as infrastructure, real estate and private equity — can provide growth and income in step with inflation.
State-backed ETFs & liquidity
The economic conditions in Japan and Singapore are markedly different, despite the common factor of their ageing societies. Japan has had a long period of persistent deflationary pressures, with a penchant for flight to safety (i.e. investors holding more yen during expected financial stress), high public debt — though this is mostly domestically held — with almost 220% debt-to-GDP in 2017 and is the highest in the world among major economies.
This is also reinforced by low immigration and an ageing workforce, which is markedly different to Singapore’s experience. What is a common feature of these market seems to be relative apathy for retail investors holding domestic stocks as a preferred form of investment.
Research by German investor manager StarCapital AG, a firm which manages mutual funds for its clients and invests in the public equity and fixed income markets, notes that Singapore’s market is undervalued, with a cyclically adjusted P/E ratio (CAPE ratio) of 12.8 as at 31/12/2018.
Despite many portfolio firms accounting for a not insignificant portion of aggregate market capitalization on the SGX, Temasek Holdings, with assets under management (AUM) of US$235 billion as at 2018, has done little to support Singapore’s equity market liquidity. Meanwhile, GIC, ranked as the third most influential and powerful asset owner globally by CIO, with an AUM estimated between US$359 billion and US$398 billion in 2018, continues to allocate its own capital and Singapore’s pension assets to equities abroad.
A substantial body of business scholarships illustrates the role that pension fund and major local institutional investors play in underwriting market liquidity — the bourses of major financial centres like Tokyo, Sydney, Seoul and New York exemplify this —but Singapore’s institutional investors are content to allocate capital to equities abroad.
By comparison, the neighbouring Kuala Lumpur bourse maintains a smaller yet highly active market, due to the involvement of the Malaysia’s pension funds in trading. While the amount of foreign funds in Malaysia is small, equity investments by the federal Employees’ Provident Fund (EPF) contributes to underwriting liquidity on the Bursa Malaysia.
“The importance of domestic equity pension funds on stock market” by Garcia and Sanjuan, published in the Spanish Journal of Finance & Accounting in 2017; “The impact of institutional investors on equity markets and their liquidity” by Dezelan, a thesis published by the University of Amsterdam in 200; and “Institutional investors, information asymmetry and stock market liquidity in France”, by Ajina, Lakhal and Sougné, published by the International Journal of Managerial Finance in 2015, highlights the role that institutional investors like pension funds play in supporting the growth of capital markets and underwriting liquidity.
Aggregate assets under management (AUM) by Singapore’s Ministry of Finance and its affiliates stands in excess of US$1.1 trillion, with the MAS reporting US$290.27 billion in official foreign reserves as at October 2018. As a percentage of Singapore’s 2018 GDP, estimated at US$359.62 billion by the International Monetary Fund (IMF), it holds reserves valued at 80.7% of Singapore’s GDP.
The MAS could model their approach after the BOJ ‘sinvestment strategy, bypassing the political sensitivities of tapping CPF monies. However, such a strategy risks of distorting equity markets; June 2018 saw the BOJ reportedly emerge as a top-10 shareholder in 40% of Japan’s listed enterprises -
Critics of the BOJs’ ETF purchasing scheme argue these investments distort the governance of Japanese companies. But advocates maintain this is a misconception, with asset managers continue to manage the proxy voting rights for the ETFs in which the BOJ invests.
The MAS can invest in index-linked mutual funds or ETFs, appointing banks and establishing a money trust with the bank that purchases beneficiary interests pursuant to a specific mandates, such as a focus on small-cap stocks or technology firms. This could significantly reinforce local equities and boost participation by both retail and institutional investors.
For instance, allocating some of its significant reserves of perhaps between between S$12 billion to S$24 billion — daily securities trading volumes on the SGX average S$1 billion — in index-linked funds can generate a more liquid environment and spur the growth of the local ETF cluster. Singapore-based ETFs require a minimum capital commitment of S$20 million to be listed, but need an AUM between S$100 million to S$150 million to break even.
These investments can be rebalanced on a quarterly basis, with relatively modest capital commitments unlikely to distort prices significantly. Moreover, such allocations could be weighted towards small and mid-cap stocks on the Mainboard and Catalist, as large-cap stocks naturally aggregate liquidity and due to their size, stability and promise of dividends.
Such a move is not without precedent, as in May 2014, Temasek Holdings seeded US$500 million with Dymon Asia Capital to place with new hedge funds.
Conclusion
Singapore’s equity capital markets are strong in certain sectors and could emerge as a compelling listing destination on the basis of its ability to attract and distribute international capital— the bourse is in close proximity to what are predicted to be the worlds largest economies — and has a strong ecosystem around it.
However, 2018 has seen the Indonesia Exchange (IDX) surpass Singapore in terms of IPO volume, while Vietnam unseated Singapore, emerging as the largest IPO fundraiser in Southeast Asia. These developments represent a turning point for the SGX, which was formerly the largest bourse in the region.
Unless the perennial issue of liquidity is resolved and investors have sufficient safeguards — the insolvency of Noble Group has reduced the confidence of a sizeable segment of the investor base — it will continue to be inhibited in its ability to attract issuers to pursue primary, let alone secondary listings.
Singapore’s public sector with its approach to state capitalism has arguably been a catalyst and investor in the country’s economic development and innovation ecosystem. Now is the time for its public sector to intervene and take steps to create a liquid securities market. Otherwise, the SGX risks being marginalised further and falling behind its regional peers.
