Commentary: How to bring the retail investor back?

Date: May 14, 2018

First published in Straits Times on 14 May 2018

It is disappointing to read that only 10 per cent of Singapore retail investors believe their investment adviser or firm always puts their interests first, compared with a global average of 35 per cent, based on a study reported in The Business Times last month.

The study commissioned by the CFA Institute also found that less than half (47 per cent) “trust or completely trust” the financial services industry. Although this was better than the global average of 44 per cent, it was the third-lowest score in the Asia-Pacific.

The overall findings were described as a wake-up call for the industry to “come together and build stronger confidence and trust” among retail investors.

In “SGX needs to give a lift to small investors” published in The Sunday Times on April 15, ST Business deputy editor Dennis Chan wrote of a “general malaise that has fallen on the stock market as far as retail investors are concerned”.

Another report noted that actual retail volume daily could potentially be only 15 per cent of dollar turnover and that the biggest stumbling block to increased retail participation is confidence in the stock market.

Put together, these reports suggest that retail investors are largely not actively participating in local stocks for two main reasons. First, losses caused by the collapse in the oil and gas sector, and the dent in confidence brought on by a succession of governance failures ranging from S-chips to the penny stock crash of 2013 to the present circumstances surrounding big names Midas Holdings and Trek 2000. Second, the perception of property as being a much less risky alternative.

Nevertheless, the Singapore Exchange (SGX) is well known internationally to be a real estate investment trust (Reit) market, and today we see more international Reits being listed here. SGX is also very strong in its derivative products, but these are designed for institutional investors.

Undoubtedly, also playing a part is the fact that many high-quality companies were delisted in the past 10 years, with the void created by their departures largely filled with small, less investment-worthy Catalist firms with no appreciable track records.

In short, even if retail investors trust their trading representatives (TRs), their faith in the stock market appears to have been shaken.

To be fair, the disillusionment of TRs with equities started years ago when commissions were deregulated and “cheaper and faster” started permeating all aspects of daily life. Investors then wanted to pay as little brokerage as possible, thus vastly reducing the incentive for TRs to offer advice, while trading systems became lightning-fast with programs written to exploit the tiniest inefficiency. With all traders and investors sporting mobile phones equipped with every conceivable social media app, news can spread within seconds of release.

If the situation is to improve, all parties must play their part. Companies have to take governance seriously and those that are majority owned by one or two parties must ensure the rights of the minorities are given due regard. A mindset change is needed, from “us versus them” to “us and them”, the necessary thinking being that if all stakeholders work towards the common good of the company, then everyone benefits.

In this connection, companies must view their minorities not as adversaries but as business partners whose interests are important and worthy of being preserved. Firms should therefore ensure they have robust disclosures and shareholder engagement practices in place so that all stakeholders are kept abreast of latest developments.

Similarly, shareholders should also take the position that they are partners who share the common objective of value maximisation. Engagement with management should be constructive and open and, hopefully, on a regular basis. Minorities must not approach boards at meetings with suspicion and contempt. They must maintain decorum at all times.

Brokers, too, have to play a part as they are the stock market’s front-line service providers. Consider that one of the biggest complaints from TRs since the US sub-prime crisis of 2008 was that regulators had become overly protective of retail investors with rules so stringent that few TRs dared offer advice or recommendations to their clients. This was cited as a big factor behind a drop in retail participation over the past decade.

However, SGX clarified in March last year and issued a guidance note saying that TRs are allowed to give ERA (execution-related advice)/recommendations on listed excluded investment products to clients, provided they state the rationale for their ERA.

“This could be based on technical or fundamental analysis conducted by the TRs, reports issued by other research analysts, or market developments/performance/ events,” said SGX and the Securities Association of Singapore. In other words, almost all forms of “buy” and “sell” recommendations are allowed as long as the TR can explain why he made those recommendations. This allows TRs tremendous flexibility in servicing their customers, yet there does not appear to have been an appreciable rise in retail participation.

One way to try and attract retail investors back into the market is through good, independent research of lesser-known but quality companies. Unfortunately, cost-conscious broking firms have been progressively scaling back their research coverage, with the result that large portions of the market are today not covered.

If anyone were to embark on expanded coverage of the local market, it is essential that the research produced be independent. This is because studies have shown that retail investors are more in need of guidance and good advice than their larger counterparts because they can be more easily misled by biased reports.

In “When security analysts talk, who listens?” by Mikhail, Walther & Willis, published in The Accounting Review in October 2007, the writers found that large investors tend to trade based on the information contained in analyst recommendations, but small investors tend to simply react to the fact that a recommendation has been released, regardless of the information in the report.

They also found that small investors not only trade more than large investors following upgrade and buy recommendations, but also trade more following upgrade and buy recommendations than they do following downgrade and hold/sell recommendations. “Consequently, large traders generate statistically positive returns from their trading, while small traders generate statistically negative returns from their trading. These findings are consistent with large investors being more sophisticated processors of information, and provide some support for regulators’ concerns that analysts may more easily mislead small investors”, concluded the authors.

If retail investors are more in need of guidance, and given that there does not appear to be an appreciable increase in retail participation since rules governing permissible advice were relaxed a year ago, then in the rush to embrace technology, speed and offer the cheapest rates, have brokers lost sight of the fact that they owe their clients a fiduciary duty?

In our view, although disruption is forcing industries everywhere to evolve quickly and their participants to adapt in order to survive, cheaper and faster should not be pursued at the expense of providing professional guidance to the retail public. While there should always be scope in stockbroking for TRs to provide superior advice, guidance and service to their retail customers – even if margins today are razor-thin, retail investors must rise to the challenge through education and knowledge, learning to manage their investments through adequate appreciation of risks and actively managing their portfolio. Only when all of the above are in place can we see greater sustained participation of retail in our market.

David Gerald
Founder, President & CEO
Securities Investors Association (Singapore)