Gov’ should fund equity research

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.




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  1. Fortunately for me I have a client advisor that does this very task. It pays off very nicely.

  2. Interesting proposal, but I think it would remove a lot of the fun to be had in the small cap sector for the investor who has the motivation/time to do their own research.

    Why give the institutional investors an edge like this in yet another sector of the market?

    The small cap sector is prime for the smaller investor to get their hand dirty in, talk with management directly (how many of the ASX100 CEOs would be prepared to devote time to the investor with $10k to spend like is the case in the small cap sector?), read through (and actually be able to understand) their basic profit/loss statements and financial reports, find those obscure announcements that news sites haven’t picked up on…

    Why would we want the government doing this and removing the edge for the smaller investor?


  3. It might also allow governments to see that Australian innovation is world class and offer grants before they pack up and ship overseas

  4. I guess getting government involved does risk making a mess of it, and it would have to be arm’s length. Plus it might very well remove Bullion’s fun. But we definitely have a structural problem in funding innovation.

  5. Dave From Pakenham

    I like your point on cartel funding from superannuation.

    Having spent some time overseas, it was quite shocking to return to Australia and witness the huge structural problems our forced savings system have produced.

    The worlds highest formalised pension to GDP ratio has created such structural biases in our economy that has stifled innovation, research etc. With the ever growing super pool, and the increased concentration of pension managers has resulted in a financial system that can only write tickets to the largest of listed companies, thereby concentrating industry, bloating middle management, subsidising non value add service industries and paying senior execs riduclous salaries for gouging consumers. Not one of our top 20 co’s and there CEO’s ex CSL has created anything in the way of productivity or innovation in the past 20 years.

    Australia is now the most expensive country in the world in which to live, cyclically exacerbated by the resource boom, of course, but primarily caused by the equity biased financial economy which provides risk capital to a concentrated banking system, that can only put money to work, where it is backed by property. We have a system that no longer lends on cashflow, just on un sustainable asset growth.

    Further, the real economy starved of financing is now is held hostage by the shareholder (once agin the first and only example in the history of the world), Telstra, Mining Companies etc, where proper public policy cannot be enacted because of vested interests.

    The Australian economy is a basket case, once China unwinds, this crazy isolated mess that we have created will have to be re-enginered, and superannuation as we know it changed forever.

    The fact that Cardia is listed, highlights the absurdity of a system that is so Equity focused, that our best risk capital ideas must seek a secondary listing to obtain such….

  6. Dave From Pakenham

    PS. A winning contrarian trade is so rewarding, targeting companies long or short and providing liquidity to consensus and crowded trades is such a profitable exercise. How wonderful it would be if I could bet against the research of a government agency…

  7. Spot on, Dave! Why do these people get paid so much when they do not innovate (except on how their bonuses are structured)?

    • Agreed S.O.N – when I was working in portfolio management, I was appalled at how much the fund managers got paid, for pretty much no extra level of service.

      Capital guaranteed products were a particular case in point – the fees were outrageous!

      On the one hand, the SGC has been good for the country, but it makes the fund managers fat and lazy. Consider that there are 10,000 managed funds, but only 2200 entities listed on the ASX….

      Dave from Pakenham, you are spot on: one of things we struggle with at our investment company is witnessing the absolute dearth of talent and innovation in corporate Australia – except when it comes to designing brilliant remuneration structures.

      It’s surprising to find the occasional financial reports (almost always from the littler companies: e.g 1300 Smiles (ONT) is a pearler – great CEO) that have more pages dedicated to commentary and insight than how the executive options work….

      Contrarian value trades are fun (if sometimes frustrating – look at FSA e.g) – both from top (e.g shorting the never-ending resource boom story) and bottom (long the forgotten non-ASX200 types).

      • Dave From Pakenham

        Prince you are right about the lack of insight, information and opinion in annual reports, just 2 pages of glib commentary and the occasional segmental breakdown.

        A far cry from the dozens and dozens of pages of commentary, analysis and information found in 10-k’s and european/uk annual reports.

        I will set aside some time tomorrow to look at ONT.


  8. Another way to boost innovation would be to allow the creation of limited liability partnerships.

  9. Perhaps fun wasn’t the right word 😉

    As a small-mid cap punter/investor I have made some decent $ the past two years in Gold/Silver plays. From my perspective I wouldn’t want to see such a scheme introduced as it would reduce the potential for the dedicated individual to discover undervalued and under appreciated stocks to buy.

    Peter made a good point earlier regarding the extra liquidity pushing up the price. A lot of extra interest in a $5-$10m m/cap stock doesn’t just mean more buy/sell depth, it likely means a significant push higher in price, whether it’s deserved, whether the stock is ready or not.

    Take a look at the ASCI recommendations during the weeks after a new recommendation, the stocks often go absolutely nuts for a short period, sometimes though the stock is just not ready for a *sustainable* move higher and so they drop back down. Imagine the effect a publicly available government endorsed tip sheet would have on some of these stocks! The tips would be turned into quick pump and dumps, those stocks that reviewed poorly would struggle to raise capital and it would seal their fate…

    I agree with Sell on News and The Prince that we need more funding for innovative companies and ideas here in Australia, I just don’t agree with a Government funded small cap tip sheet is the way to do it 🙂


    • Dave From Pakenham

      I think the point being made here by Sell on News, all be it tongue in cheek, is that conflicted, short termist analysts employed by Investment Banks can only recommend liqiuid large caps to generate brokerage and ECM revenue. Buying and selling these beasts does little for our economy and society.

      These recommendations fail to beat the market but exhaust so much of the commissions paid by clients. So perhaps its conceivable that even a government department could do a better job of uncovering businesses, business models and leaders who are actually contributing to portfolio performance, resource allocation, employment and society. And if unsuccesful at least that government department would be a cheaper less conflicted alternative!

  10. Why does government need to fund small cap research?
    Why can’t the massive fees I pay, and everyone else pays, for investment of superannuation pay for this?
    The high level of pay in the funds management industry is appaling. Most of them invest in the ASX200 plus or minus small variations – a computer could do as much. They are providing nothing more than an administration service in most cases yet are paid as though they are bringing real expertise and value to the investment process. What a load of bollocks. Most fund managers should not be paid any more than competent public administrators.
    Rant over.

  11. A very interesting idea. Maybe we should get rid of the ratings agencies and have the government provide basic credit research too! I say that tongue in cheek, but why do we need them? I must get around to writing a post about that…