| In-depth analysis needed to navigate dislocated market |
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| With unprecedented levels of volatility in Irish equities, it is more important than ever for stockbrokers to offer clients an in-depth, case-by-case analysis of domestic companies, writes Roy Barrett. |
Finance’s annual survey of Irish stockbrokers consistently shows that our clients have the same two key requirements – the provision of liquidity and of high quality independent research. We, as Irish brokers, therefore see continuity of both research coverage and stock liquidity through difficult times as being the cornerstone of our ongoing success. | | Roy Barrett |
The current weakness of the Irish equity market is exceptional; we did have a long bear market in the early part of the decade, but in that situation Ireland was merely following an international trend. It is not since the early 1990s that Irish stocks have been so out of favour with international investors, and then the catalyst for recovery was the devaluation of the Irish pound. In this context, it is more important than ever that we focus on our clients’ two key requirements to maintain international interest in Irish shares. The market’s recovery is dependent on the emergence of improved economic fundamentals, which provide the basis for research analysts to maintain a more optimistic perspective, and the perception of liquidity in Irish shares is key to drawing in investors who need to be able to trade in very large size.
The most important constituency of ownership of Irish equities is the international institutional investor. Despite the intense competition for Irish equity business amongst global brokers, many investors are keen to execute orders in the local market, as they rightly perceive that local brokers can and do deliver best prices on execution.
Liquidity in Irish equities increased dramatically over the last few years, with daily trading volumes growing from €430 million in 2005 to an average of just over €800 million in 2007 year to date. The dislocation in the market in recent months has happened against a backdrop of high volumes. October’s daily volume came in at €790 million, which matched the range €750-850 million for each of the first three quarters. However, bid-offer spreads have widened considerably, thus increasing the cost of execution.
Provision of liquidity has undoubtedly been a challenge in the Irish market in recent months, as sentiment has reversed and buyers have been thin on the ground. We at Goodbody, more than any other broker, have maintained our commitment to providing liquidity in the Irish market. We will continue to do so, for the best research in the world is useless unless investors can trade on our recommendations. It is likely that international investment banks will have many higher priorities next year than making prices in Irish equities, so we anticipate that our presence in the market, and our ability to make prices for clients, will be particularly important in 2008.
The recovery of the Irish market, when it comes, will be driven by a range of investors. It will not be an Irish phenomenon, but an international one - the vast bulk of investors in Irish equities are now based outside the country. They will, however, need to have a comprehensive knowledge of the Irish companies they invest in, and the capacity to execute their transactions effectively.
In recent months, volatility has increased across all markets. One factor driving this is the high proportion of market dealings which are now driven by rapidly generated orders from automated trading systems. These have tended to have disproportionate effects on stock prices and created a challenge to our determination to maintain liquidity. These trades tend to follow algorithms and pre-determined recursive steps are put in place which set triggers for execution. The technology assumes that the market is more liquid than is the case in current circumstances.
In strongly directional markets, such automatic trades can exacerbate any underlying trend. As other investors watch price movements, the trend can feed on itself. This instability is typical of a period of rapid price dislocation, and the effect tends to disappear once the major adjustment has taken place. We, therefore, anticipate that while automated trading is undoubtedly here to stay, and likely to increase in importance as a result of the Markets in Financial Instruments Directive (MiFID) and other regulatory developments. The volatility caused by such activity will reduce.
This is where the importance of the continuous, in-depth, research coverage that we can provide as Irish brokers comes in. While the large international brokers cover some of the bigger stocks, and release occasional high profile reports on Irish companies which can create momentum for hedge fund traders, long term value investors will always seek to talk to analysts who cover companies on a continuous basis.
The challenge for our analysts now is to form a realistic view of the prospects for Irish companies, while acknowledging on the one hand that the glory days are over for the time being, but avoiding the temptation to get caught up in the maelstrom of pessimism that is in danger of enveloping all companies, whatever their prospects. This requires case-by-case analysis of each company, with universality of coverage important in a market which has always had a disproportionate weighting in financial and cyclical stocks. I am confident that our analysts are navigating their way through these choppy waters - one measure of this is the relatively equal balance between accusations that on the one hand, they are talking down the market, and on the other that they are naively optimistic.
A trend which has emerged in recent years is the increasing discrimination of institutional investors in allocating their commissions. Traditionally, commission followed dealing activity, now it is quite possible that an institution will do a basket index trade with an international investment bank, incorporating some Irish equities, and that we as Irish brokers will separately be remunerated for our research through an 'unbundled' commission payment. We believe that this approach will reward our determination to provide in-depth coverage.
Our business is built on providing this continuity and depth of research offering, and I believe that this will never be more important than in the coming year, when we can anticipate major dislocations at the international investment banks, and a focus by them on markets where activity can be more readily generated.
The third part of our institutional offering happens outside our offices, and in tandem with the companies who make up the market. We have, over the past few years, developed our corporate broking service, which interacts with listed companies, and allows us back up our research views with direct investor access to management of Irish plcs. Being members of a small market means that all except the largest and most internationally diversified Irish companies have to make disproportionate effort to have their story heard. Because we constantly have teams meeting with investors all over the globe, we are in a position to help companies meet clients who will be receptive to their story. The coming year will be one in which the facts about Irish companies will need to be clearly told on the international stage, and we look forward to playing an ongoing role in that effort. |
Roy Barrett is chief executive officer of Goodbody Stockbrokers.
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