My co-blogger, The Prince, has devised a fine scheme to fund innovation that might prove highly effective. Which is why it will never happen, most probbaly. Still, to continue the practice of tilting at windmills, I wish to propose something else that might prove effective (and so also will probably never occur). Public funding of research on small stocks in the ASX. The problem is extremely well known; one hears it all the time from the institutions. There is virtually no research on small cap stocks so institutional investors cannot blame someone else if something goes wrong. That is a core skill, so institutional investors rarely risk investing in small stocks.
Having government fund research on small stocks would not be a case of government picking winners, although the analysis would presumably pick winners (and losers, too). It would take the heavy focus off banks and miners and a couple fo duopolies. And it might offer an alternative to the automatic funding Australia’s cartels get from superannuation contributions. A system that is, if not corrupt, certainly a little smelly.
Add up the banks, miners, Telstra and the supermarket duopoly and the concentration of the market becomes pretty obvious. Nine stocks: Wesfarmers, Telstra, Woolworths, NAB, Westpac, Commonwealth Bank, ANZ, BHP and Rio account for about half the market cap of the ASX of $1.3 trillion.
It creates an investment loop that only rewards size. Investors go for the big cap stocks because they are liquid and safe, which makes the big cap stocks liquid and safe. It penalizes innovation, because cartels do not innovate, they protect market share. We are seeing that in an extreme form with the milk wars, as The Age commented.
Take a small stock like Cardia Bioplastics (CNN), which produces hybrid plastics for packaging that becomes viable if the oil price hits about $90 a barrel. Ever heard of it? Probably never will, but it could be an effective oil play.
The brokers do look at “emerging industrials” but they usually already have sizable market caps – and there is a heavy concentration on mining, for obvious reasons. For instance, Macquarie’s Emerging Leaders Weekly nominates, Mt Gibson Iron, Grange Resources, Aquila Resources and Mincor Resources as stock that may have been sold off too much.
UBS has a buy on Graincorp and a price target of $9.40, which it has as an “emerging industrial”. Yet the stock has shareholders’ equity of $1.3 billion. Not exactly a start up. Deutsche Bank calls Equinox Minerals an emerging industrial, and it has a market cap of $4.6 billion and sales approaching $1 billion.
The benefit of government funding research on small stocks is that it would not distort price signals, nor woudl it be necessary to create the mechanism. It already exists. There is a desperate need for better information and that is where government can help.