The incredible shrinking market making new highs

Published in The Sunday Times on April 21st 2024.

With all the hoopla around the Japanese market reaching a new high previously set 34 years ago, a milestone event closer to home went largely unmentioned. The ISEQ index of Irish shares, breached the 10,000-point level this month for the first time since February 2007. When you consider that other stock markets took only until 2013 to exceed their pre-financial crisis highs, the Irish stock market has lagged behind its European and US peers significantly.

This doesn’t mean investors have been underwater for the last seventeen years, though. The ISEQ index is quoted in price return terms, so doesn’t include the dividends that companies pay. If we take the total return index, then it broke back through its previous high in December 2020. That’s still a frustrating 13-year hiatus for anyone unlucky to have invested at the peak. It stands about 40% higher today than its peak 2007 level, representing a paltry 2% return per annum.

The make-up of the index today is very different to when it first broke through the 10,000 level. Financials make up about a quarter of the index today compared to a peak in 2007, when banks made up more than half of the index. The total market capitalisation of the ISEQ today is a shade under €100bn, having shrunk considerably following the recent exits of the two largest stocks on the market – CRH and Flutter Entertainment. Both eyeing the deep and liquid capital markets of the US in preference to Ireland – a phenomenon also afflicting stock markets in the UK.

The Irish stock market’s woes couldn’t be more at odds with the success of the Irish investment funds industry. Ireland has become a centre of excellence for investment funds and is currently the second largest fund domicile in the European Union. It is the EU’s leading location for exchange-traded funds and one of the largest domiciles for money market funds.

According to Statista, the total market capitalisation of world stock markets is c. $112trn. So, the Irish stock market represents a very small portion, approximately 0.1%, of this total.

Twenty years ago, I was working for an Irish asset management company. Our managed pension fund had an allocation to Irish equities of about 5% while our peer asset managers averaged around 20%. There were some local considerations, access to management being one, that could justify a larger than benchmark allocation. However, when Irish companies make up about one in 1,000 of the globally quoted peers, it’s very hard to justify one in every five stocks owned being Irish.

What prompted the clustering of pension fund managers around that spurious 20% average was career risk – closing out the risk of performance deviating too far from peers by essentially mimicking them. Things are very different today. Peer group performance is no longer printed every month in the main papers. Quarterly asset allocation surveys are not poured over to the same extent. And the inexorable rise of passive management has changed the game. Passive funds are allocated exactly as per proportionate size. There’s no room for home, or any other, bias. 

The shareholder register for Irish stocks today is very different from twenty years ago. Irish pension funds, pressed by consulting firms, have significantly reduced their exposure to Irish equities in the last couple of decades. The shareholder register today reflects a combination of passive managers holding stocks to fulfil their mandate of tracking indices and active managers that see discrepancies between price and value. The legacy holders of my day are all but gone. 

The cost of trading Irish equities, particularly for quantitative managers, is a deterrent, thanks to the to the 1% stamp duty levied on purchases. Other EU markets have various levies, but Ireland’s rate of 1% is by far the highest. The UK charges 0.5%. In the context of the recent exodus from the Irish market to the US, the case for changing this looks strong.

Retail investors make up a certain proportion of the share register and have a particular home bias. Analysis of all trades executed in 2023 by Davy execution-only clients revealed a top-ten most actively traded stock list that included all Irish names, bar one. Tesla was the only non-Irish name to make it into the top-ten of most actively traded shares in 2023. 

It should matter little whether a market is 0.1% or 10% of global benchmarks. The ultimate goal of investing is to generate a return and those returns are greatest wherever the gap between the publicly quoted price of a stock and its intrinsic value is widest. That gap should be borderless. Yet the more a market becomes overlooked, the greater the potential for those gaps to persist. 

There’s no quick fix to the shrinking pool of publicly quoted Irish companies. Companies will go wherever they see the best opportunities to create shareholder value; investors equally so. In the search for value, you don’t have to look very far. 
 

Source: Data is sourced from Bloomberg as at market close 29th December, returns are based on total indices in local currency terms, unless otherwise stated.

Gary Connolly is Investment Director at Davy. He can be contacted at gary.connolly@davy.ie or on twitter @gconno1.