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News and discussions from Novus Capital

Financial markets are still betting on rate cuts this year

Gavan Farley - Wednesday, May 15, 2019


Financial markets are betting official interest rates will be cut in three months time, with the likelihood of another reduction later this year, despite the Reserve Bank indicating this week that the case for lower rates had not been made.

After the central bank left official interest rates on hold at a record low of 1.5 per cent on Tuesday, markets have slightly pared back expectations of rate cuts this year. But many remain convinced that the RBA will soon lower borrowing costs.

All eyes will be on the jobs data in the months ahead, especially the unemployment rate, amid debate over which figures best reflect the health of Australia's economy: the weak economic growth figures or the stronger labour market numbers.

On Wednesday, ANZ head of Australian economics, David Plank, said futures markets had "fully priced in" a 0.25 rate cut in August, and there was a "pretty high" chance of a second cut of this size by the end of the year.

"The market went from pricing more than two [interest rate cuts], to a bit less than two, by early next year," said Mr Plank, who also expects rates will fall this year.

National Australia Bank chief economist Alan Oster said a key reason why rates had been left on hold this month, despite very weak inflation and two quarters of soft economic growth, was that the RBA had more faith in the monthly employment data than the numbers on gross domestic product. Latest ABS figures showed an unemployment rate of 5 per cent in March.

When the RBA left rates unchanged on Tuesday, Governor Philip Lowe highlighted the importance of jobs data, saying further "improvement in the labour market" would probably be needed to get inflation — which was just 1.3 per cent in the year to March — back inside its 2 to 3 per cent target range.

Mr Oster, who is forecasting a cut in July, said if the unemployment rate rose for a few months in a row, that would probably be enough to trigger an interest rate cut.

"The unemployment rate is critical. If it starts going north, that's a problem," Mr Oster said.

Mr Oster argued the labour market was weaker than the 5 per cent rate of unemployment would suggest, pointing to the high proportion of people who would like more hours of work.

Among the big four banks, Westpac is also tipping further interest rate cuts this year, while Commonwealth Bank is currently forecasting no change.

Mr Plank said markets would be seeking greater clarity on the RBA's views on the state of the economy in the RBA's Statement on Monetary Policy this Friday, and a speech from Dr Lowe later this month.

Dr Lowe on Tuesday also noted a recent decline in bank funding costs, pointing out that even though some lending rates had declined, average mortgage rates were unchanged.

Mr Plank said that if any reduction in bank funding costs were passed on to variable rate borrowers it would be a "modest easing" from the perspective of the RBA, and was unlikely to meaningfully influence the outlook for employment or inflation.

There is also uncertainty over how long banks may take to lower their variable rates, if at all, and whether their funding costs will remain at current levels.

Source: The Sydney Morning Herald


Reserve Bank holds interest rate steady ahead of Federal election

Gavan Farley - Wednesday, May 15, 2019


The Reserve Bank of Australia has kept the official interest cash rate on hold for the 33rd consecutive month, just days ahead of the Federal election.

The rate will remain at 1.50 per cent, where it has sat since August 2016.

Reserve Bank Governor Philip Lowe said today's decision to extend Australia’s longest-ever period of steady monetary policy followed below-target inflation, steady employment growth and a nationwide housing downturn.

"The Board judged that it was appropriate to hold the stance of policy unchanged at this meeting," he said in a statement.

"In doing so, it recognised that there was still spare capacity in the economy and that a further improvement in the labour market was likely to be needed for inflation to be consistent with the target.

"Given this assessment, the Board will be paying close attention to developments in the labour market at its upcoming meetings.

The announcement comes ahead of the Federal election on May 18.

Domain economist Trent Wiltshire said the RBA is “very likely” to cut rates twice in 2019, bringing the cash rate down to a new record low of one per cent.

“The RBA has been reluctant to cut rates despite a slowing economy and weaker than expected inflation due to strong jobs growth and low unemployment," he said.

"But with such low inflation, the RBA has changed to an ‘easing bias’ and will cut rates in the next few months."

Mr Wiltshire said the lower interest rates will boost the housing market and slow further house price falls.

CoreLogic head of research Tim Lawless agreed that a rate cut was likely this year.

“If the cash rate does move lower later this year, a reduction in mortgage rates would provide some support for housing demand, however we may not see quite as much stimulus for housing market conditions that we have seen after previous rate cuts,” he said.

“Generally, housing sentiment remains low and borrower mortgage serviceability is still assessed based on mortgage rates of at least seven per cent.

“Households who already have a mortgage, or prospective borrowers who are able to satisfy lender credit policies will be the winners if interest rates do fall later this year.”

Many economists and analysts tipped a cut after last month's official data showed inflation slowed to zero in the March quarter.

But KPMG Australia chief economist Brendan Rynne was among those tipping the RBA to sit on its hands for a little longer.

Source: The 9 News



New edition of ASX Corporate Governance Council’s Principles and Recommendations Released

Gavan Farley - Thursday, April 04, 2019


On 27 February 2019, the ASX Corporate Governance Council (Council) released the fourth edition of the ASX Corporate Governance Principles and Recommendations (Recommendations). The Recommendations apply to all entities listed on the ASX, but are also useful for non-listed companies that are looking to implement best practices.

The updated Recommendations will take effect on 1 January 2020 for entities with a 31 December balance date, and on 1 July 2020 for entities with a 30 June balance date. Entities are encouraged to adopt these Recommendations earlier if possible.

What has changed?

The key changes to the Recommendations revolve around the culture and values of entities in the context of community trust and confidence. The Council ‘considers it imperative’ that listed entities align their culture and values with community expectations in light of a number of examples of listed entities falling short.

The wording in the Recommendations has been changed to state that an entity must ‘instil’ and ‘continually reinforce’ the culture of the organisation, suggesting that there is an ongoing positive obligation on the Board to maintain the appropriate cultural standards and oversee its progress. The new Recommendations contain 35 recommendations as compared to the 29 recommendations in the 3rd edition of the ASX Corporate Governance Principles and Recommendations.

Out of thirty-five Recommendations, the following are entirely new recommendations for listed entities:

  • Recommendations 3.1 – to articulate and disclose its values to the public;
  • Recommendation 3.3 – to establish maintain and disclose a whistle-blower policy and ensure that the board (or a committee of the board) is informed of any material incidents reported;
  • Recommendation 3.4 – establish and disclose an anti-bribery and corruption policy, and ensure that the board or a committee of the board is informed of any breaches;
  • Recommendation 4.3 – to disclose its process to verify the integrity of any periodic corporate report that it releases to the market that is not audited or reviewed by an external auditor. This raises the bar for corporate reporting best practices;
  • Recommendation 5.2 – ensure that its board receives copies of all material market announcements promptly after they are made;
  • Recommendation 5.3 – a listed entity that gives a new substantive investor or analyst presentation should release a copy of the presentation materials on the ASX Market Announcements Platform prior to the presentation in order to ensure equality of information among investors;
  • Recommendation 6.4 – ensure that all substantive resolutions at a meeting of security holders are decided by a poll, rather than by a show of hands, as a show of hands is thought to be inaccurate; and

The following four Recommendations have been updated and elaborated:

  • Recommendation 1.5 –disclose the full text of its diversity policy and disclose measureable objectives set for a reporting period to achieve gender diversity. The suggested objective is no less than 30% of each gender for directors. Previously, the Recommendations suggested that entities only disclose a summary of their diversity policy;
  • Recommendation 2.2 – it is suggested that a board should now disclose and regularly review its skills matrix to help the board identify any gaps in collective skills of the entity that need to be addressed. This will also assist with succession planning for management; and
  • Recommendation 2.6 – it is recommended that a listed entity should have a program for inducting new directors. There should also be a program for periodically reviewing if there is a need for existing directors to undertake professional development, legal training on framework and duties as a director, as well as induction training.
  • Recommendation 8.1 – in addition to the board of a listed entity being required to have a remuneration committee with at least three members, a majority of whom are independent directors, a listed entity included in the S&P/ASX 300 Index is now required under Listing Rule 12.8 to have a remuneration committee comprised solely of non-executive directors for the entire duration of that financial year.

There are also new Recommendations which are perhaps more uniquely relevant to some listed entities:

  • Recommendation 9.1 – if a director of a listed entity does not speak the language that board meetings are held in, the entity should disclose the process it has in place to ensure the director understands and contributes to discussions at board meetings (such as providing translation copies of material documents to be tabled). This is to assist the director to discharge his/her directors’ duties; and
  • Recommendation 9.2 – if a listed entity is established outside Australia, it should ensure that meetings of securityholders are held at a reasonable place and time;
  • Recommendation 9.3 – if a listed entity is established outside Australia has an AGM, or where an externally managed listed entity has an AGM, the entity should ensure that its external auditor attends its AGM and is available to answer questions from securityholders relevant to the audit.

What remains the same?

The new Recommendations maintains the same flexible non-mandatory ‘if not, why not’ approach to disclosure, whereby a Board is entitled to not adopt a principle, but must explain why it has not adopted the recommended approach.

The new Recommendations have the same structure of eight core principles and accompanying supporting recommendations. The eight core principles are as follows:

  1. Lay solid foundations for management and oversight: A listed entity should clearly delineate the respective roles and responsibilities of its board and management and regularly review their performance.
  2. Structure the board to be effective and add value: The board of a listed entity should be of an appropriate size and collectively have the skills, commitment and knowledge of the entity and the industry in which it operates, to enable it to discharge its duties effectively and to add value.
  3. Instil a culture of acting lawfully, ethically and responsibly: A listed entity should instil and continually reinforce a culture across the organisation of acting lawfully, ethically and responsibly.
  4. Safeguard the integrity of corporate reports: A listed entity should have appropriate processes to verify the integrity of its corporate reports.
  5. Make timely and balanced disclosure: A listed entity should make timely and balanced disclosure of all matters concerning it that a reasonable person would expect to have a material effect on the price or value of its securities.
  6. Respect the rights of security holders: A listed entity should provide its security holders with appropriate information and facilities to allow them to exercise their rights as owners effectively.
  7. Recognise and manage risk: A listed entity should establish a sound risk management framework and periodically review the effectiveness of that framework.
  8. Remunerate fairly and responsibly: A listed entity should pay director remuneration sufficient to attract and retain high quality directors and design its executive remuneration to attract, retain and motivate high quality senior executives and to align their interests with the creation of value for security holders and with the entity’s values and risk appetite.

How does this affect you?

You should consider the latest Recommendations in detail and update your policies where necessary to comply with the new Recommendations.

If you are a listed entity with a full financial year commencing on or after 1 January 2020, you are required to report against these new Recommendations from 1 January 2020.

If you are a listed entity with a full financial year commencing on or after 30 June 2019, you are required to report against these new Recommendations from 1 July 2020.



Australian IPO Report 2018 - HLB Mann Judd

Gavan Farley - Wednesday, February 20, 2019

Total funds raised in initial public offerings (IPOs) in 2018 hit $8.44 billion, up 106 per cent on the 2017 total of $4.09 billion, although the pipeline into 2019 reflects a softening of the market, according to the latest HLB Mann Judd IPO Watch report.

“Despite the increase in funds raised, there were only 93 initial public offering (IPO) listings on the ASX in 2018, down from the 110 new market entrants in the previous year, but in line with the five year average,” said Marcus Ohm, author of the report and partner at HLB Mann Judd Perth.

“Unusually, for recent years, there were a number of $1 billion+ cap companies listing during the year.

“The three largest IPOs of the year (Viva Energy Group, Coronado Global Resources Inc. and L1 Long Short Fund Limited) raised $4.75 billion between them – 64 per cent of the total funds raised.

“As well as being one of the few growth sectors for the year, the Materials sector recorded the most listings – with 35 listings representing 38 per cent of all IPOs undertaken – compared to 29 listings in 2017.”

Continuing the trend of the past few years, small cap companies – those with a market capitalisation of less than $100 million – continued to make up the bulk of new entrants to the IPO market, Mr Ohm said.

“There were 72 small cap IPOs undertaken during the year, down on the 88 of the previous year, but nevertheless representing 77 per cent of the total IPO market.

“The total also remains well above the previous five year average of 50 listings.”

Mr Ohm said some companies had difficulties raising capital during the year, and this is reflected in the total number of IPOs that did not meet their capital raising goals.

“Only 72 per cent of all new listings were able to meet their target, which was down on both the 2017 and 2016 years which saw 79 per cent and 83 per cent of targets met respectively.”

Mr Ohm added, on average, IPOs in 2018 experienced an underwhelming share price performance subsequent to listing.

“New markets entrants recorded an average first day share price gain of 5 per cent, but only 47 listings ended their first day above their listing price – a rather poor result given that the issue price of these IPOs was typically discounted.

“Year end gains were disappointing too, as on average, new IPOs for the year decreased in share price by 18 per cent by year end. This is a worse performance than other market indicators, with the ASX 200 recording a decrease of 7 per cent for the calendar year.”

The year end losses made by a significant number of IPOs in 2018 and general market conditions suggest that there is likely to be a reduction in IPO activity in the coming six months, Mr Ohm said.

“Unsurprisingly only 17 companies had applied to list on the ASX at the end of 2018, well down on the 37 that had applied at the same time in the previous year.

“The companies that have applied are hoping to raise $179 million, which is a 70 per cent reduction on the $603 million sought at the end of 2017.

“Materials stocks made up the majority of the proposed listings with seven listings, showing market sentiment still remains for this sector.

“Overall the pipeline appears to be soft and reflects the performance of IPOs and the wider market. This was evidenced in the final quarter of 2018 with sentiment perhaps being an important factor.

“Companies considering listing will need to clearly articulate their offerings and provide sound investor communication.”

HLB Mann Judd is an Australasian association of independent accounting firms and business and financial advisers, with offices in Australia, New Zealand and Fiji.

* Emerging, or small cap, companies are defined in this report as those with a market capitalisation of $100 million or less. All data excludes property trusts.

2018 - Half Year IPO Report

Gavan Farley - Wednesday, August 29, 2018

Deloitte Half Year 2018 IPO Report

IPOs struggle to make first half mark as second half looks brighter

Australian IPOs delivered a muted performance in the first half of 2018, with more losers than winners, but positive global performance, a record year for US markets and strong local economic fundamentals, provide a real sense of optimism going into the second half.

Key Points from Deloitte's latests IPO update covering the half year yo 30 June 2018 include:

  • 40 companies successfully listed, raising $1.8 billion, compared to 57 listings in the same period in 2017
  • 16 (40%) experienced negative returns, with weighted average performance of -1.5%
  • Financial services was the dominant sector, accounting for 89% of the capital raised - however listed investment funds represented a significant proportion of the raising
  • Only 10 (25%) of the listings raised capital in excess of $75M
For more on this topic  go  to  Deloitte's  Australian website

2016 IPO Report - Good year for for Smaller Companies

Gavan Farley - Friday, March 17, 2017


2016 IPO Report: Good Things Come In Small Packages

2016 was a strong year for Australian companies floating on ASX. The number of IPOs rose to 96 (from 85 in 2015), implying an average of eight per month or two a week – certainly enough to keep the most active investors busy... Though the absolute number of new floats increased, the market capitalisation at listing of these new ASX entrants was lower in 2016 than the prior year. Signalling a return to the smaller end of the market and, in the fourth quarter, a degree of ‘deal fatigue’ on the part of investors as many of the larger floats planned for this traditionally busiest quarter of the year were pushed into 2017.

On performance, investors had little reason to complain on average: IPOs outperformed the ASX200 index by 18% and returned an average of 25% at year end. And more so because the best performance was seen at the smaller end of the market. New floats that issued less than $50 million outperformed those that issued more than $50 million by 17.5% at year end, an encouraging statistic for investors taking a portfolio approach to IPO investing.

First day returns were also impressive and increased by 5% on the prior year, indicating either strong aftermarket support and a good investor following, or a strategy to leave some room for a price rise in the way new issues have been priced.


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Living in a VUCA World

Gavan Farley - Wednesday, November 23, 2016

Living in a VUCA World

Today I was fortunate enough to be invited by a good friend and associate at Cube Capital Hani Iskander to attend a quick briefing by the owner of Williams Inference, John Trudgian. Williams Inference, a business intelligence service, was started 1965 in the USA by James Williams and is based around the idea that by observing human behaviour, looking for anomalies, one could spot trends early and take advantage of them to build into your investment strategies. The service is subscribed to mainly by major fund managers, and they get a quarterly presentation from John or one of the team, which distils collates and interprets information from over 200 publications, financial markets, books film TV and the web.

A world wind one hour ride

John took us on a ample ride through his most recent quarterly report. We only had an hour… (it normally takes two or three) The theme of this report, which was written before Trumps upset victory is summarised in the following quote…:

“We are moving from a world of problems, which demand speed, analysis and elimination of uncertainty, to a world of dilemmas, which demand patience, sense making and engagement with uncertainty” – living in a VUCA world

Birds are Singing Earlier

We started with…. Noise and a story about how naturalist are observing how birds are beginning their dawn chorus some two hours before sunrise. The reason given is that we humans are making so much noise, that the birds have to start earlier and earlier, in order to be heard… this story lead onto developments in technology designed to bring back some peace and quiet. Noise cancelling head phones, especially amongst professionals such as pilots is a big and developing market…

Talking not Typing

the noise theme then morphed into new ways to interface between our ever-present device, and the problems of using Siri, Cortana and other voice user interfaces in our devices. It turns out that the main reason that these devices don’t work as well as they should is due to background noise. Aftercall we can speak on average 150 words a minute but type at less than 40 wpm. This lead to an article about a firm called Kopin that has a completely new approach and can achieve accuracies over 90% in standard environments… Kopin predicts that this breakthrough will mean that by 2020 50% of queries will be voice generated.

Augmented Workforce

From Voice and smartphones, we made a small leap to augmented reality and its use, not in gaming but in industry, healthcare, training for high risk jobs, and inevitably … to how the porn industry is adopting to this new technology….

No Sex in Japan

From there we were lead across the se to Japan where changes in demography and family structure such that 70% of Japanese under 34 are single and 40% are still virgins, and just across from Japan, China is experiencing significant declines in marriage rates and increasing divorce rates. India the same. So what, you might say; these things have been happening in the west for decades, but that’s the point, what has taken two or three generations to happen in the west, is happening in these counties within one generation. What concerns, opportunities can be inferred by these trends….

The Device Man

And now our next stop on this whirlwind tour was around the theme of device people… our addiction to phones and online communication and how it is changing how humans interact. I commented to the group on how some people check the current weather on their phone, while sitting next to a window. People sit at the same table, texting each other…

Serial Dating – Serial jobs

this led to dating sites, the gig economy, the lack of security, permanence, planning for the future, even how the use of cosmetics has spiked as people (men and women) put on makeup, not to look better in person, but to make them look better in photos, selfies. Did you know that campus bookstores in the USA now have large cosmetic sections., which then led to a story on how Deutsche Bank is now using technology for matching people on dating sites to match new recruits. our hour was almost up… and we looked at the gender gap in the work force particularly in the upper echelons, and why it is so persistent… but no time to pause and we had to move on… we touched on money, dynamic pricing, such as Ubers surge, Amazons variable pricing, and the feedback loop to earlier mentioned trends of piece meal work,, the zero hour on-call work contract, instant and serial dating…

The VUCA World

and finally at the 55th minute… we arrive at the VUCA world. VUCA.. purportedly a US military acronym… coined at the end of the cold war, standing for Volatile, Uncertain, Complex and Ambiguous.

Thus our journey ended, but it was an amazing trip that generated so many ideas m of how things connect, or not. The skill in investment management is to try to take a view of what all these things going on around us might mean. We are often so busy, just doing our daily routines, living in our bubble, we can’t get out. We should do it more. You can get more info on John @ http://competitiveintelligence.ning.com/profile/JohnTrudgian. The web site http://www.williamsinference.com/ is undergoing a re-vamp but there is some great archival material there


Snap Inc IPO

Gavan Farley - Friday, November 18, 2016

It is hard to see how Snapchat parent Snap will live up to expectations after its IPO

David Glance, University of Western Australia

Snap, the parent company of Snapchat is looking to go public with an IPO in March of 2017. Snap has filed its intentions secretly with the US Securities and Exchange Commission (SEC) and it is expected to be valued at between US $20 and $25 billion. Snap’s current earnings are not publicly disclosed but because its filing with the SEC was private, they are thought to be less than US $1 billion per year.

There was a time when the public’s enthusiasm for social media companies was such that Snap’s valuation would never have been questioned. When Twitter listed on the stock market, it was valued at US $25 billion, a price only made believable by the optimistic view that Twitter would eventually find a business model that would drive phenomenal growth. It didn’t do that of course, and 3 years later, its value is 50% of that initial value, it is laying off staff and it recently couldn’t persuade anyone that it was worth buying. Twitter is now a company with few prospects and facing enormous challenges to put in place meaningful ways of generating revenue.

Given how hard it is to find ways to make money from social media outside of advertising, it is not clear how Snap intends to make the sort of money that would justify its very high valuation. Facebook has succeeded so far with advertising because the platform is ideally suited to finding out a great deal of information about users that can then be used to deliver targeted ads in multiple formats. But even Facebook is starting to find that there is a limit to how many ads they can load onto someone’s news feed.

Twitter and Snapchat are at an immediate disadvantage as advertising platforms because they have far less capacity to find out meaningful information about their users but also far fewer options of how to present them ads. Both Snapchat and Twitter are hoping that they can transform themselves into media companies and get their users to consume video from companies through their platform. However, in the media space, they are up against much better competitors like Google, Facebook, Amazon and even Apple.

Snap has recently branched out into hardware with the launch of Spectacles, sunglasses that are fitted with a camera that can take short videos to store and publish through Snapchat. Although Snap’s Spectacles are certainly less geeky than Google’s Glass glasses, they may suffer from the same social stigma that ended Google Glass as a consumer product. It is also not clear why people would want to wear glasses with camera on the off chance that there was something worth filming for 10 seconds. Even if “Specs” is a successful product, it still would only generate a tiny fraction of the revenues that Snap will have to make to justify its price.

The other challenge Snapchat faces is in its core functionality and the battle for users’ time. Snapchat’s features have been largely duplicated by Facebook’s Instagram. Instagram also has twice the number of daily active users than Snapchat.

The difference between the two services is in the type of communication that each allows, Snapchat’s original focus was on disapearing messages that could be used for “sexting”. Although this has become a smaller part of the reasons why people use Snapchat, the ephemeral nature of Snapchat messages is really about humorous, but essentially trivial, types of communication.

Other apps like Facebook Messenger and WhatsApp also now allow secure and private communication making Snapchat less unique.

Unlike Snapchat, Instagram tends to encourage photos that are more considered, encouraging a broader range of quality and communication. This is mostly because the photos are enduring and intended for larger audiences. At the end of the day, a social network is where your friends are and all of them are likely to be on Facebook, far less likely to be on Snapchat.

There is an overwhelming sense that Snap is trying to raise money for its service now, because it can. Seeing Twitter’s struggles must be a sharp reminder that staying relevant as a social media platform is not a given, despite early success. Snap will also find that being public and having its performance constantly scrutinised is going to be extremely tough going.

For shareholders and investors, IPOs are known as an “exit strategy”, a way of realising the gains on your investment or unlocking the value of your shares as one of the founders or employees. An exit strategy may be appropriate in the case of Snap given that it will be incredibly hard to maintain revenue growth when your principle audience is extremely young and fickle.

The Conversation

David Glance, Director of UWA Centre for Software Practice, University of Western Australia

This article was originally published on The Conversation. Read the original article.


Why Stock Market Panic can Signal a good time to Buy

Gavan Farley - Tuesday, November 01, 2016

Explainer: why stock market panic can signal a good time to buy

Lee Smales, Curtin University

Financial markets around the world are responding to current political uncertainty in both Australia and the UK by sending stocks, bonds and currencies on a rollercoaster ride.

The far-reaching implications of Brexit caused the S&P/ASX 200 volatility index (A-VIX) to spike to the highest level since the start of 2016. Similarly, the A-VIX jumped 5% in the opening minutes of trading on Monday after it became clear the federal election would remain unresolved.

Investor sentiment (A-VIX) responding to political uncertainty.

The VIX essentially gives an indication as to the market expectation of price volatility over the next 30 days. Since the main participants in the option market tend to be investors seeking protection against declining prices, the VIX tends to rise when investors are anxious about falling markets – giving rise to the colloquial term of the “fear gauge”.

Why investor sentiment is important

In theory, asset values should be determined by competition among rational investors. Such competition makes for prices that reflect “fundamental” values - basically the discounted value of expected cash flows. But in reality we know this is not always the case. For instance, based on the discounted value of rental income, the Australian housing market is currently far above fundamental value. Essentially, “sentiment” reflects the irrational behaviour that pushes prices away from the underlying fundamentals.

The uninformed traders who exhibit this irrationality are often called “noise” traders, and theory suggests that over time they will lose sufficient capital to be forced out of the market. The trouble is, constraints can mean that even the most informed trader could become insolvent before the market reflects fundamental values. With this in mind, it is important to understand what sentiment is, how we can measure it, and how it might impact asset prices.

The theory on investor sentiment suggests that positive sentiment will drive prices above fundamental value and provide above average returns in one period. In the next period, the misvaluation will be corrected. So periods of positive sentiment are followed by periods of below average returns, and vice-versa. That is the theory, but how can we empirically test it?

A self-fulfilling prophecy

A major issue that we have is that sentiment cannot be directly observed, and so we have to use alternate measures as a proxy. A number of alternatives have been suggested, these are often based on surveys (such as consumer confidence) or market variables (such as trading positions) with varying degrees of success in explaining market movements.

A further complication in researching the effect of sentiment is that it is often difficult to disentangle sentiment from market movements as they are often self-reinforcing. To think of why this may be, consider media reporting of movements in the stock market. If the stock market goes up, then the media writes glowing reports and this entices additional “noise” traders into the market. More shares are bought, pushing prices higher, and producing further positive media commentary. This can often continue until we are in bubble territory.

Two important proxies for investor sentiment

Aside from volatility indices like the VIX, there is also a composite index that uses the principal components of six individual proxies related to market activity (this includes share turnover and the number of IPOs).

The researchers that developed this index used it to explain stock returns over a lengthy period running from 1963. They found that investor sentiment had a greater effect on stocks in small, young, and high-growth firms. The index data is available here, but ends in 2010.

Relationship between Baker Wurgler sentiment index and stock market returns.

What the research says about sentiment and returns

Research has shown that VIX and stock prices have a strong contemporaneous relationship, where VIX increases as stock prices fall. Perhaps more importantly, VIX is also useful in forecasting price movements in future periods.

When investor fear is high, stock prices are pushed below fundamental values. In the next period, when the level of risk aversion reverts to some norm, stock prices move back towards the equilibrium level and generate above average returns. This fits well with the underlying theory of investor sentiment.

Relationship between investor fear and stock market returns. Data sourced from DataStream

Interestingly, investor fear in the stock market is also informative for returns in currency markets and bond markets, suggesting that the effect of sentiment is pervasive across asset classes. And sentiment also effects the way in which markets respond to news events, such as economic data releases, with stronger, more volatile responses tending to occur when investor sentiment is low (alternatively, fear is high).

Political uncertainty can drive sentiment

Right now many investors are unsure about how government policy will impact them directly, via taxation and superannuation reform, and indirectly through the effect of policy (or lack of policy) on business investment decisions.

For many investors, this remains a time to be cautious. However, history has shown that the best returns are often to be found by buying when investor fear is at its highest.

The Conversation

Lee Smales, Senior Lecturer, Finance, Curtin University

This article was originally published on The Conversation. Read the original article.


Seven Ways to tell whether a Private Equity backed IPO should be avoided

Gavan Farley - Thursday, September 01, 2016
Mark Humphery-Jenner, UNSW Australia

Private equity-backed IPOs (Initial Public Offerings) have come under significant scrutiny following several high-profile failures: but are these representative or merely anomalous blights on an otherwise well-performing sector?

Last week, the proposed private-equity backed listing of Guvera music was blocked by the ASX following concerns raised by the Australian Shareholders Association over its business model and valuation based on earnings.

Guvera were looking to raise $100 million in an IPO that valued the business at more than $1.3 billion, despite the fact that it lost $81 million last financial year on revenue of just $1.2 million. The move by the ASX follows Guvera re-issuing its prospectus after scrutiny from the Australian Securities and Investment Commission (ASIC).

Another notorious PE-backed IPO was the 2012 float of Dick Smith, backed by Anchorage Capital. It ended in significant losses for initial investors and was dubbed by Forager Funds Management analyst Matt Ryan as “one of the great heists of all time”.

The high-profile the IPO of Myer, backed by TPG Capital, also performed poorly: Myer listed at $4.10 per share, fell to $3.75 per share on the first day of trade, and fell to $1.20 per share by the end of 2015.

However, several other PE-backed IPOs have performed strongly between 2013 and 2015, including Aconex, Ooh! Media and Mantra group. This raises the question of whether the average PE-backed IPO underperformance and what factors might investors look out for.

Do PE-backed IPOs necessarily underperform?

So should investors make a rule to avoid PE-backed IPOs in general? In fact, there is little evidence that PE-backed or VC-backed IPOs underperform for investors. In Australia, from 1994 to 2005, the difference between VC/PE backed IPOs and other IPOs is not statistically significant.

The Australian Venture Capital Association Limited (AVCAL) in conjunction with Rothschild reports that while non-PE backed IPOs did perform better in 2015 than did PE backed ones, PE-backed IPOs outperformed from 2013-2015. AVCAL argues that “PE-backed IPOs strongly outperform non-PE backed IPOs after the first year of listing”, with PE-backed IPOs outperforming non-PE backed IPOs by 23% during that one year after listing.

Similarly, Deloitte argues that “the performance of private equity backed listings suggests results are far more positive than market sentiment reflects” and that $1 invested in each PE-backed IPO since the beginning of 2013 would yield an average return of 48% by the end of 2015.

Using the set of ASX listings for at least A$100 million reported by AVCAL (and their classification of whether a firm is PE-backed), we can look at the average value of $1 invested in each of the PE-backed IPOs versus $1 invested in each of the non-PE backed IPOs.

When doing so, to avoid the possibility of outlying PE-backed firms experiencing super-positive returns and this biasing the results, the daily return is winsorized (limiting of extreme values) and any return over 100% is excluded (this adjustment actually biases in favor of the non-PE backed IPOs).

The below graph, which is consistent with that produced in the AVCAL report, demonstrates that PE-backed IPOs outperform their non-PE backed counterparts. A similar trend appears over longer two-year and three-year time horizons (though, more recent IPOs will not yet have had the opportunity to accrue such a lengthy return history).

Average value of $1 invested after an IPO in PE-backed and non-PE backed companies in the sample.

The findings its wrong to suggest PE-backed IPOs do not underperform on average - while there are some instances of underperformance, the average PE-backed IPO actually performs strongly.

Seven factors investors should consider

This suggests that PE-backed IPOs do not necessarily underperform. But clearly, not all PE-backed IPOs will outperform either. So here are seven factors associated with post-IPO performance investors should look for:

  1. Length of investment. The length of the PE-fund’s involvement with the company will help to indicate if the PE fund actually contributed to the company. In several poorly performing PE-backed IPOs (such as Myer and Dick Smith) the PE fund had invested for only one to two years. When at least part of that time is also spent preparing the company for listing, this would likely be insufficient time to fully transform the company. Clearly, the time required to improve the company will depend on its complexity, but a typical situation would often call for several years of PE-investment prior to IPO.

  2. Prior litigations. Companies backed by VC and PE funds that have been sued recently (or for whom their portfolio companies have been sued) warrant further scrutiny. Funds that have been sued have difficulty attracting future funding and if investors are reticent to invest in the fund itself, it could imply beliefs about how the fund might manage companies it lists on the market.

  3. The backer’s portfolio size. VC and PE funds that are larger and invest in more portfolio companies tend to perform worse because they spread themselves too thinly across portfolio companies, suggesting that their portfolio companies my perform worse.

  4. Distance between the company and its backers. The geographic distance between the PE (or VC) fund and the portfolio company could be a concern. For example, an overseas based fund might face greater barriers to a successful outcome.

  5. Number of backers. A company with more interested pre-IPO investors is likely to have greater growth prospects and has more scope for the disparate investors to pool their expertise to aid the company. However, there are diminishing returns to having more backers, with each additional supporter likely to have less scope to incrementally benefit the company.

  6. Geographic diversification of the backers. To an extent, a backer who has supported more companies in multiple industries and multiple regions can have gained a breadth of experience and connections with which to impart the portfolio company. There are limits, with excess diversification potentially causing the fund to spread its attention too widely. The fund’s record would help to indicate whether such diversification has benefited the fund’s investments previously.

  7. PE fund’s continued involvement in the company. It is generally a positive signal if the PE fund that continues involvement in the form of board positions or ownership stakes (exceeding the minimum time, or amount, legally required).

Essentially, while investors should always examine each IPO on its merits, there is no reason to avoid PE-backed IPOs per se.

The Conversation

Mark Humphery-Jenner, Associate Professor of Finance, UNSW Australia

This article was originally published on The Conversation. Read the original article.