SURVIVAL OF THE FITTEST
As the number of listed companies in Scotland and the UK continues to fall, Bill Jamieson remains positive that those which deliver the best returns will continue to flourish
Financial guru Bill Jamieson remains positive about the future of listed companies
Aglaring paradox presents UK and Scottish private investors as the New Year unfolds: despite a powerful surge of funds into equity funds and trusts, the stock market is shrinking even further out of favour.
Inflows into UK-focused funds hit a two-year high in December with more than £330 million pouring in during the two days following the election, according to fund settlement service Calastone. More than £740 million cascaded in during the 13 trading days in the month after the result.
It marked a dramatic turnaround in sentiment towards UK stocks and funds, notably out of favour in the three and a half years since the 2016 referendum vote in favour of leaving the EU. And that surge looked set to continue through January and February. Retail investors pulled £13.7 billion from UK equity funds since the Brexit referendum, according to Investment Association data. UK stocks’ pariah status was also reflected in an exodus from global fund managers, who have maintained an average 28% underweight since the Brexit vote, according to regular surveys from Bank of America Merrill Lynch.
But barely noticed in this stampede back into the UK equity market is that the opportunities for equity investment overall have continued to shrink.
A long-term decline in the number of quoted companies continues apace. Back in 1999, the number of companies listed on the London market stood at 2,093. Today, that has shrunk to 1,146, a decline of 45%.
Fewer than one UK company in 2,500 is now quoted on the Stock Exchange. And the number of listed smaller companies has fallen even more: in 1999 there were more than 1,200 on the market. Today there are fewer than 400.
In Scotland, the decline in the quoted company universe is at least as severe and the decline longstanding. According to figures compiled by Paul Marsh, Emeritus professor of finance at London Business School, and Scott Evans at Walbrook Economics, the number of Scottish stocks has slumped from more than 200 in the mid-1960s to less than half that number – to just 100 by 2014.
The number of Scottish stocks within the UK total has also fallen. At the start of 1955, Scottish stocks made up 7.4% of the UK total. This total held steady until the 1970s. It peaked at 9.5% at the start of 1996, reflecting the privatisations of the 1980s and growth of the Unlisted Securities Market (USM). But from its 1996 peak, it has fallen steadily to 5.1% by 2014.
In a paper entitled The Scottie 100: Sixty Years of Scottish Stocks, published at the time of the Scottish independence referendum, the authors concluded that ‘the importance of Scottish stocks has therefore declined over time relative to the UK as a whole, whether we look at the number of stocks or at their value’.
Neither Scotland nor the London stock market are alone in this trend. Around the world, the number of companies listed on stock markets fell in 2019 to a three-year low. Several factors have been at work. Chief among them has been globalisation – the rise in large companies operating across borders, with the concentration of finance and administrative functions in one central location.
Another has been the relentless rise in private equity, with company ownership concentrated in a tiny number of institutions and high net worth individuals. Regulatory burdens and costs associated with wider share ownership have also militated against the historic offer for sale model: companies attracting an initial surge of private investor interest
found the number of small holders shrinking dramatically after a few years.
So much for the high hopes of the Thatcher era that the UK was set to enjoy a transformative rise in shareholder democracy. According to Chris Dillow, veteran market analyst at the Investors Chronicle, ‘this steady decline in the number of listed companies tells us something important – that the market believes that, in many cases, it is not a good idea for companies to be owned by many dispersed outside shareholders’.
He ascribes this less to rising administrative and regulatory costs than to a fundamental flaw in the concept of wide and diversified share ownership: very few have the incentive – or often the ability – to properly monitor management.
As with all models of universal ownership, when it seems everyone has the power to monitor and control management, no-one has. The expertise – and the technical software – needed to exercise control are unequally distributed. Very few private investors have the time to undertake serious and sustained monitoring.
At the same time, investment firms have found it is not worth the effort to provide analytic coverage of smaller quoted companies – with regulatory requirements now forcing a separation of the audit function and provision of investment research. For this, clients are now charged separately – and many have baulked.
This has left shareholders in many quoted companies badly exposed. In the UK, the Big Four accountancy firms all fell short of the Competition and Markets Authority’s quality audit requirements during 2019, with none of the firms able to surpass the watchdog’s 90 % ‘good quality audit’ target.
Separately, many of the Big Four also found themselves at the centre of both the CMA and Financial Reporting Council’s wrath throughout the year. Accountancy giant Deloitte came under fire for errors on its 20092011 audits of Autonomy.
KPMG was fined £5 million by the FRC in 2019 after a £1.5 million black hole was found in the accounts of the Co-op Bank – which KPMG had audited for 40 years.
Then there was EY’s experience with now-defunct Thomas Cook after numerous auditing mistakes were found to contribute to the travel company’s September demise.
Trucking company Eddie Stobart found itself halting stock sales in August after a £2 million accounting-based error was found in its 2018 accounts. And luxury fashion chain Ted Baker discovered its stock value was overstated by up to £25 million in a severe blow to its auditor, KPMG.
All this adds to a broader disillusion with the quoted company model, with investor disquiet extending over issues ranging from excessive boardroom pay to the concentration on shortterm profits at the expense of sustainable longer-term earnings. The private equity and venture capital models are that concentrated ownership keeps managers under tighter and more professional scrutiny.
Now there is more questioning and scepticism over the merits of a stock market listing. ‘It’s no accident,’ says Dillow, ‘that the past two decades have seen not only a fall in the number of listed companies, but also poor returns on many of those companies that are still on the market.’
The decline in listed equities, it seems, may in time be doing the universe of investors a broader favour as the quoted survivors are more likely to deliver better returns.
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In Scotland the decline in the quoted company universe is severe