Back in 2016, the Malta Stock Exchange introduced the Prospects MTF Market � an interesting addition to the local capital market. Today, over two years later, ten securities have been admitted to this market which targets small enterprises in search of raising capital or established companies wanting to raise finance for specific projects.
Prior to the introduction of this capital market, smaller enterprises had very limited opportunities when it comes to financing, mainly restricted to bank financing. The Malta Stock Exchange felt the need to offer a more flexible and affordable alternative to such businesses, while maintaining the crucial high standards of corporate governance and transparency.
Considering the probable lack of experience of the issuer in the capital markets, the Malta Stock Exchange requires the appointment of a corporate advisor, whose role is to guide the issuer during the admission process and beyond - throughout the whole duration of the term of the security. This ensures that a high level of governance is maintained by the issuer for the benefit of investors.
From the investor point of view, the introduction of the prospects market represents new investment alternatives with different risk-reward characteristics. Apart from the secondary market opportunities, such issues can also address the high local demand for bond investors. Needless to say, these opportunities should be considered in the context of each individual portfolio and risk profile, and therefore are not appropriate for risk averse investors.
One of the roles of the corporate advisor is to make sure that the continuing obligations are fulfilled throughout the life of the bond. One possible responsibility in this regard is ensuring that the proceeds which the company receives from the bond issuance are used in the manner described in the admission document. This can be done through the use of an escrow account which would initially receive the proceeds and only release the funds to the issuer in portions, when certain predetermined criteria are met.
This way, investors have the peace of mind that even though the borrower of their money can be a small institution, third party professionals are involved in the whole process, acting as an independent watchdog on their behalf. This is crucial in instilling investor confidence in the market.
Ultimately, investors must decide if the risk reward trade-off is reasonable
Maltese investors should be somewhat familiar with many of the risks associated with the size of these kinds of businesses, considering that half of the organisations listed on the main market fall within the definition of small-to-medium enterprises. Having said this, one should keep in mind that most companies admitted to the prospects market are usually even smaller in size than those listed on the main market.
There are various risks inherent in the prospects market, with liquidity being one of the main concerns for investors. The problem arises from the fact that no issue in the prospects market can be larger than €8 million, and to reach that figure there are certain restrictions regarding the number of investors who can participate in the issue. Inevitably this results in a smaller pool of investors at inception, meaning that there will be a smaller number of buyers and sellers on the market at inception but can grow as the instrument starts to trade as the restriction on the number of investors would no longer apply. If the issue is less than or equal to €5 million, then this could be offered to more investors.
An alternate view is that the problem of illiquidity reflects the fact that investors participating in bond issues by and large invest on a buy-to-hold strategy, which is rather understandable considering the higher coupon rates usually associated with these issues.
As at time of writing, seven bond issues of the nine admitted to the prospects market were issued with a coupon rate of 5 per cent or higher, rates which have not been seen of late in the main market issues. One should look at these additional yields as a premium, or in simpler words, as an incentive for investors taking on the additional risks of these issues.
Whether or not this premium properly compensates for the actual risks of investing in such small, usually highly-leveraged companies and given the problem of potential illiquidity, is debatable. Ultimately, investors must decide if the risk reward trade-off is reasonable, depending on their views of the financial soundness of the issuer, as well as the investors’ risk appetite and the investment strategy being used.
In order to make an informed decision on whether the additional risks are properly compensated by the yields, it is ideal to estimate how much this all-important premium is in the local market.
In reality, every single security presents the investor with different, perhaps even unique, risks and thus, in theory the risk premium of each issue should vary to reflect its underlying risks. Even so, we can get an idea of the average premium.
The average yield-to-maturity of main market bond issues maturing in nine to 10 years, based on the prices at the time of writing, is 3.63 per cent. However, the average yield-to-maturity for the bonds in the Prospects MTF Market is 4.94 per cent. Based on these figures, the premium that an investor would receive on average, for investing in the prospects market, is 1.31 percentage points.
In a market of low yields, this could be an interesting addition to consider as part of a portfolio. There are certainly good investment opportunities in this market but, as with any other securities market, the key is to identify the companies with solid, profitable projects in the pipeline. As a potential investor always bear in mind the risk-reward trade off, and whether you are being fairly compensated for the risk exposures which you are introducing to your portfolio, while always keeping in line with your long-term strategies.
This article was prepared by Andrew Borg, B.Com (Hons) Banking and Finance (Melit.), Trader at Jesmond Mizzi Financial Advisors Limited. This article does not intend to give investment advice and the contents therein should not be construed as such. The Company is licensed to conduct investment services by the MFSA and is a Member of the Malta Stock Exchange and a member of the Atlas Group. The directors or related parties, including the company, and their clients are likely to have an interest in securities mentioned in this article. Investors should remember that past performance is no guide to future performance and that the value of investments may go down as well as up. For further information contact Jesmond Mizzi Financial Advisors Limited, 67, Level 3, South Street, Valletta, on 2122 4410, or e-mail email@example.com.
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