Sunday, January 3, 2010

Investment Ideas: Asia-Pacific Stock Exchanges

In this article we deviate from the usual single-minded focus on macro-economic analysis and shift more towards the financial market aspects with a look at an investment idea. What spurred me to write on this topic was comments around a New Zealand analysis article, another way to benefit from the development and overall level of economic (and financial market) activity of a country is to invest in listed stock exchanges.

The reasoning goes that as an economy becomes more prosperous, more and larger companies will grow and develop. A portion of these companies will list securities on a public exchange...

Value driver no. 1: listings revenue
Most exchanges derive a decent chunk of earnings from annual and initial listing fees. This provides a stream of almost annuity-like income for the exchange (as long as it has a compelling listing franchise). It will also provide new income as new companies list and existing companies list additional securities e.g. rights issues, convertible notes, different classes of shares etc.

Flowing on from that, as more companies list securities on the exchange, and as people in the country become wealthier (and as growth prospects improve-thereby attracting international flow), more and more trading activity occurs. As more trading activity occurs and as financial markets and participants develop and become more sophisticated demand for exchange traded derivatives e.g. futures and options, also grows...

Value driver no. 2: trading revenue
A significant earner (about 50% according to the WFE) for exchanges is the fees that they charge for providing the market infrastructure. This does vary by exchange e.g. value based fees, transaction based fees, volume based fees, maker-taker pricing, etc. And depending on the exchange may also include post-trade 'clearing' and 'settlement' fees (if the exchange has that infrastructure).

As more and more market activity goes on, the demand for services such as market data and IT services grows.

Value driver no. 3: services revenue
Another earner for exchanges is the revenue they generate from charging for access to market data. They will also generate income from services like IT, software, and market operations, investor relations services, and so-on.

So basically it all stems from companies listing their securities on a public exchange. This lays the foundation for trading activity and market development, which drives demand for other services such as data and software.

And (sorry to repeat) as an economy grows; as will demand for, and size of, listings; as will demand for trading of securities and derivatives; as will demand for related services. To illustrate the impact of economic prospects (or specifically, investor expectations thereof), you need only look at the Hong Kong exchange (see below), whose stock price is up about 2000% since 2000 (clearly linked to the remarkable growth and growth prospects of greater China).

With that, let's have a very brief look at some of the listed Asia-Pacific region exchanges.

1. Hong Kong
Hong Kong Exchanges and Clearing Limited (HKEX), is uniquely positioned as the gateway to China. You can see in the stock chart the impact of market activity as the stock price surged around the 2007 boom and bust (sure this is also a product of valuations, but the point of growth prospects remains). Going forward the economic growth prospects story for the HKEX is probably strong given the growth prospects of greater China. However HKEX may face pressure from the growing (and retail flow driven) Shanghai Stock Exchange and Shenzhen Stock Exchanges.

2. Singapore
The Singapore Exchange (SGX) benefits from Singapore's reasonably well established position as a South-East Asian financial hub. Thus while the Singapore economy will have a strong impact on the performance of this exchange, it will also reflect the prospects of the wider South-East Asian region - and will be strongly influenced also by general levels of global financial market activity and confidence.

3. Malaysia
Bursa Malaysia (Bursa) has its claim to fame as the world's biggest palm oil futures trading hub. It also has a healthy domestic cash equities and derivatives business. Thus it is a play on the Malaysian economy (both in that it is a large producer of palm oil, and with the equities business being driven also by the domestic economy), as well as indirectly palm oil, and again the wider South-East Asian region.

4. Australia
The Australian Securities Exchange (ASX) has benefited from a strong Australian economy and reasonably well established financial markets. Prior to the global financial crisis it enjoyed a strong run-up, but has been held down in recent years due to market sentiment and lower earnings. The ASX is a good play on the Australian economy (whose prospects are generally pretty good as far as developed economies go), but may face a little pressure on trading fees as Chi-X and NZX are both seeking to set up alternative trading systems there.

5. New Zealand
The New Zealand Exchange (NZX) is generally affected by the New Zealand economy, but with limited room for growth within New Zealand in it's traditional business it has increasingly diversified in recent years; putting an emphasis on data and research businesses, particularly in the agricultural space. NZX recently also acquired electricity market assets in New Zealand and grain market assets in Australia, and is seeking to set up clearing and settlement infrastructure in New Zealand. Thus given the importance of Agriculture to the New Zealand economy, and the domestic cash equities business NZX is a reasonable way of gaining exposure to New Zealand.

In summary, listed exchanges are generally a good way of gaining exposure to the economies in which they operate, because strong economic activity will generally lead to more activity on exchanges and greater earnings. But given the peculiarities of each exchange you need to thoroughly understand what drives the business before pulling the trigger.

Going forward a key threat and opportunity for this sector will be the timing of a sustained recovery from the global financial crisis; this sector will win from a strong and sustained returned to economic growth as well as a recovery in financial market activity and confidence. It's pretty clear that this will happen eventually, but the key will be in the timing.


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