A number of behavioural biases have been revealed in research commissioned by the Australian Securities and Investments Commission into the way investors approach prospectuses for initial public offerings. Too often, investment decisions are based on intuition – a ‘gut feel’.
ASIC found that many retail investors describe familiarity with a brand as part of the reason for investing. There is a tendency to develop a preference or positive predisposition towards familiar names and business concepts.
Once this initial sentiment has taken hold, investors tend to look for information that confirms their initial predisposition, rather than adopting a neutral position. In this way behaviour is affected by confirmation bias.
In some cases, there is tendency to discount information that contradicts the initial predisposition. Confirmation bias can cause our focus to narrow into “tunnel vision”.
Investors are also affected by social bias, where they take a lead from trusted peers and sources. Some investors say they rely almost solely on recommendations from friends and family they perceive as having investment experience or previous success.
When assessing risk, people have shifting thresholds for dealing with uncertainty and they often miscalculate risk.
Investors take a great interest in IPOs, and for good reason. New sharemarket listings returned almost double that of the broader market in 2016, according to a Deloitte study.
The number of new ASX listings was 152 in 2016/17, up from 124 the previous year. IPOs on the ASX raised $6 billion in 2016.
When ASIC surveyed institutional investors, it found that they rely heavily on prospectuses when assessing an IPO. But retail investors are different – influenced by a broader range of sources, including analysis provided by a wide range of financial commentators.
ASIC is using the market research to review its regulation of IPOs, aiming to make sure that investors have confidence in them.
Institutions value prospectuses because they are the main source of information about an IPO and because they are regulated documents for which directors and others involved in the offer have liability. Institutional investors also recognise that prospectuses are lodged with ASIC and subject to regulatory oversight.
In general, retail investors value information they perceive to be independent and easy to understand.
The financial media, including mainstream media and subscription services, are influential in alerting retail investors to potential IPOs and in influencing the decision-making process.
While the prospectus is seen as a key source of information, many retail investors say the documents are hard to read and cannot be relied upon to tell the whole truth about an IPO. They are also seen as marketing documents.
A number of retail investors say they want more information about the issuing company’s management – its track record and the skills executives bring to the business. And a number say the risk factors set out in prospectuses are too generic.
“It is likely that prospectuses will always be challenging documents for less experienced retail investors to read and understand,” ASIC says in its report.
Many of the participants in the survey were able to articulate sound factors they took into account before investing – for example, how the issuer planned to make money; the expertise of management; competitors operating in the same market; the issuer’s financial position; and the specific risks the issuer might encounter.
Some investors thought that ASIC assessed whether companies met certain merit-based criteria before listing and that it reviewed all prospectuses (which it does not).
Based on the research, ASIC says its regulation of IPOs is sound. However, it plans to make some changes. It will continue to review a significant proportion of prospectuses and undertake targeted surveillance.
In 2016, ASIC obtained corrective disclosure 134 times, issued 56 interim stop orders and five final stop orders.
It says issuers and advisers should consider ways to improve investors’ access to information about issuer’s management. ASIC will explore ways to give investors better access to management through roadshows and online forums.
Disclosure about risks must be specific to the issuing company. And the investment overview should include a plain English explanation.
ASIC will also increase its monitoring of the wide variety of sources of information available to retail investors about IPOs. These include investment newsletters, magazines and subscription services dedicated to investing.
It will review whether such coverage is clearly identified as paid advertising, rather than independent editorial-style content.