GCC stock markets: Where is the research?

Compared to most developed and emerging markets, the Gulf Cooperation Council’s stock markets suffer from poor research coverage.

The four largest GCC equity markets together enjoy less than a third of the research coverage of other regions, with that available often restricted to large stocks, leaving mid-cap and small-cap stocks mostly ignored from the spectrum.

In the GCC, the major producers of research are a handful of domestic banks and investment houses, which haveresearch as an auxiliary function focussing predominantly on the sell-side segment.

A lack of international players and independent research houses has led to limited research offerings. In the Reuters database, since the beginning of 2015, there have been 17 reports on SABIC (market cap $61.6bn), the biggest company in the GCC, compared with 155 reports on Tata Consultancy Services (India, market cap $69.3bn) and 303 on Apple Inc. (United States, market cap $560.2bn).

The number of analysts following SABIC, TCS and Apple Inc. are 14, 51 and 47 respectively, showing the extent to which research coverage lags behind in the Gulf region.

The predominant consumers of research – funds and companies – are a minority in the regional stock exchanges, accounting for less than 30 per cent of the value traded. Retail investors in some countries account for more than 70 to 80 per cent of the liquidity.

While this compares well with China, where about 85 per cent of trades are retail, in India over 70 per cent of market liquidity occurs due to foreign institutional investors. The retail investors in the developed markets account for only 10 to 30 per cent of liquidity and the institutional investors account for the rest.

Therefore, the important factors that determine the extent of analyst research coverage in a country are the proportion of institutional investors, breadth and depth of the markets, extent of foreign investment, number of players in the market and, finally, transparency and openness to sharing forward-looking statements by companies.

The overwhelming presence of retail investors has led to investments that are primarily driven by sentiment, speculation and word-of-mouth information rather than analytical research. This has led to increased market volatility compared to developed markets.

The top-heavy nature of the GCC markets, along with low liquidity and lack of investor interest in the mid and small-cap segments, has resulted in dwindling analyst research in these segments.

The lack of availability of analyst write-ups in Arabic has again led to low consumption of research in the region.

Another reason for low research focus is the uneven corporate disclosures across the GCC region, where some countries lag behind others during regular filings of financial results.

Delays in acquiring time-sensitive information and minimal public disclosures discourage analysts from following companies, as some countries seem to have relatively more lenient regulations. Also, declaration of financial results is dependent on the size of the companies, with large-cap companies releasing information at a faster rate, compared to mid-cap and small-cap companies. The region also lags behind its peers in developed and emerging markets in the strict enforcement of corporate governance rules and stock exchange rules, which has led to markets that are relatively inefficient.

Among GCC countries, the extent of analyst coverage varies based on the above defined factors. For example, coverage is the highest in Saudi Arabia, followed by Qatar, the United Arab Emirates and Kuwait. Barring Qatar, all other major GCC nations have over 88 per cent analyst coverage for large-cap stocks, due to the popularity of these stocks among the investors and the relatively higher amount of research and information available in the public domain.

This coverage value declines for mid-cap companies and falls further for small-cap companies. Despite its popularity as a financial hub, the UAE lags behind Saudi Arabia and Qatar in terms of analyst coverage of its markets, with just over one-third of the stocks covered by analysts.

While in other markets it is common to find more than five analysts covering large cap stocks, in the GCC such luxuries are restricted only to Saudi Arabia and the UAE. This is not surprising given the overall low flow of research.

Post the global financial crisis, GCC capital market regulators have tightened regulations concerning disclosures and other matters. These disclosures happen mostly on a bilateral basis with companies providing huge amounts of information to regulators but not disseminated freely for analysts to pore over. Increased regulations also add to compliance costs, which can be onerous for small and medium-sized listed stocks thereby encouraging them to delist.

Many GCC countries are in the process of improving the efficiency of exchange operations to attract more liquidity. If the rules are properly regulated and enforced, disclosures and filings will occur in a timely manner that would enable timely research to be conducted and draw investor interest. Practices that favour a select group of investor owners at the expense of minority shareholders need to be curbed and minority investors protected, to enhance institutional investor participation.

Market limits must be drawn to ensure that daily volatility on any instrument is controlled. Investment companies must also come under strict regulation to ensure control over leveraged positions, and protection of investor interests. A number of new regulations have been issued to improve market attractiveness, but the strict enforcement of corporate governance and exchange rules is necessary to improve research coverage of the country’s stocks.

The GCC stock markets are inherently more volatile than their emerging market peers, primarily due to the nascent stage of development. Therefore, managing this risk or volatility is a key criteria for institutional investor entry. A buy and hold environment may not enable this. Availability of broader tools like derivatives (options and futures) can provide the needed tools for managing volatility. Additionally, a framework for stock lending and short selling practices needs to be developed. Such measures can reduce market volatility and attract foreign investors, who can then propagate a research culture.

Consolidated, bigger markets would help to increase market liquidity and limit volatility. This would enhance confidence for market participants and consequently provide an attractive destination for international institutional investors. In addition, it would aid the research industry as analysts would be able to conduct research on a larger pool of stocks with more comparable companies.

MR Raghu is managing director at research house Marmore