Share Market Volatility – Causes and Remedies – Part Two

The Institute of Chartered Corporate Secretaries of Sri Lanka in partnership with the Daily FT organised a seminar titled ‘Share Market Volatility – Causes and Remedies,’ last week which brought to the table many issues concerning the Colombo stock market at present.

During an interactive panel discussion moderated by Daily FT Editor Nisthar Cassim, which summed up the evening’s proceedings, the panellists candidly answered some of the more pressing problems seen in the market.

From left LR Global Lanka Asset Management Managing Director Channa de Silva, CT Smith Holdings Executive Director and Chief Operating Officer Sheyantha Abeykoon, CSE Chairman Krishan Balendra, Daily FT Editor Nisthar Cassim Brandix CFO Hasitha Premaratne, Hemas Holdings CFO Malinga Arsakularatne and Capital Alliance MD Ajith Fernando – Pic by Upul Abeyasekara

The panel consisted of CSE Chairman Krishan Balendra, LR Global Lanka Asset Management Managing Director Channa de Silva, CT Smith Holdings Executive Director and COO Sheyantha Abeykoon, Capital Alliance MD Ajith Fernando, Hemas Holdings PLC CFO Malinga Arsakularatne and Brandix CFO Hasitha Premaratne along with Consultant Chandra Jayaratne who also posed questions to the speakers.

By Cassandra Mascarenhas

Q: The CSE is looking to come out with an S&P index but for so many years we’ve been trying to get into the Morgan Stanley index, so why can’t we start with that instead?

Balendra: To enter the Morgan Stanley emerging markets index, you need a minimum number of companies with a market cap and a free float of a certain size so that is a little different to the S&P index that I spoke about.

You have a S&P index in India, Australia and so on and this will be a S&P index for the Colombo market which will have certain companies that are listed on the CSE included in that index. What it will give is some degree of credibility because it will have the S&P brand and the investors will know that the criteria for inclusion will be the criteria that are commonly used by S&P in other markets in the world.

Q: We also have issues with regard to MPI’s composition. Is that being addressed?

Balendra: The MPI composition is based on certain criteria like market cap, volume and so on and instead of changing the MPI to correct some of the possible drawbacks with the inclusion criteria, we thought we would bring in an internationally recognised brand so with that, there would be some credibility as well.

Q: With the road map being spoken about, can we really aspire for a set of timelines? What suggestions can you give if we are to develop into the emerging markets index?

Abeykoon: Basically, the biggest impediment for us is size and liquidity. Our market cap is $20 billion, we have a $25 million turnover on average a day which is a turnover that has tripled over the last two or three years but that is still miniscule if you compare it to not even global standards, but regional standards.

For example the Philippines which is viewed by most fund managers as a marginal market, has a market cap of over $100 billion so it’s about five times our size and the average daily turnover there is about $100 million. A lot of the foreign investors that come to Sri Lanka like Sri Lankan companies but the problem they have is how do you take a meaningful position in this market? We need to really think about how we can improve the liquidity levels in our market, how we can give foreigners the opportunity to take a meaningful position in our market.

Q: Should regulators get involved in price discovery process?

De Silva: The answer is no because price discovery between the buyer and the seller is given the circumstances in the market, so certainly not.

Q: I think this issue went through all presentations – we need to get back to fundamentals but has the Sri Lankan market ever been driven by fundamentals?

Premaratne: If you analyse the last 25 years, there have been situations in the market where we have seen significant sudden jumps. 1992-1993 is an example of this; again people invested looking at foreign funds to come to the market and people were just buying to sell to the foreigners. What they didn’t realise was that foreigners wouldn’t buy at 25-30 times P/Es. During the era of war, there was relative valuations coming down and there was a set of investors accumulating but then 2001 gave investors a very bad signal when the airport bombing came in and the global 9/11 issue took place.

I think there have been passages in the market where people have gone to the fundamentals and if you look at the good stocks, they have performed really well. The period 2001-2006 was a good example and the starting point of the post-war era in 2009 until around September 2010; the market was following fundamentals because the entire key banking stocks, conglomerates and all the growth sectors did show positive movement.

However, if you look at September 2010 to now, you can see that situation has significantly changed so while the market was never perfectly on fundamentals, it was following fundamentals to a certain extent but I would say in the last one year, things have been very much skewed towards speculative and rumour driven trading.

Jayaratne: My first query is about People’s Leasing - some figures that are given show that over a weekend, the leasing company financed the leasing of 3,000 vehicles in Kurunegala. That tells me something very positive but also very frightening. Secondly, foreigners like the appreciating rupee and Mark Mobius has made a fantastic gain, but is it good for the market in sense of exporters and for new people to come in?

Fernando: Regarding People’s Leasing, yes their disbursements are around Rs. 5 billion a month now. I’m not sure about the 3,000 vehicles; that may be a stunt like some banks opening 10 branches in one day – those are all marketing gimmicks but are not sudden phenomena. Their monthly inflow is about Rs. 3.5 billion rupees so they are a large company and their portfolio is around Rs. 60 billion.

The industry itself has grown a 100 per cent over the last two years, 100 per cent year on year. That is to do with a pent-up demand, with the taxes suddenly coming down, peace coming into the country and the demand just exploded. The interesting point particularly in the case of PLC is that it is driven 75 per cent by commercial vehicles not by consumer cars and such. So it’s not a consumer boom that’s driving this, it is actual underlying economic growth that’s driving this growth.

This is not to continue at all, this is a one-off increase that we saw due to a basic realignment of the economy and some tax adjustments. Regarding credit quality, they have been around for 16 years so they are very aware of the credit risk and the interest rate risk and they fund over 50 per cent of their portfolio through long-term borrowings and 10 per cent through equity. So there is an element of risk involved in about 40 per cent but that is the reality in any banking business, you carry an interest rate mismatch which you manage using the best tactics available.

Premaratne: Coming from an export background, a depreciating rupee will be good for the exporter but having said that, most of the industry players are looking to see that we don’t see businesses sustaining on exchange rate depreciation.

As a country, a stable exchange rate and a consistent policy on the exchange rate is something that might be good to have and given that the inflationary environment has not been out of control in the past couple of years, I would say that the exchange rate situation prevailing at the moment is something that has favoured the businesses as a whole whereas exporters do have certain complaints, again that leads to exporters improving their efficiencies.

Arsakularatne: On the same point, one worry that comes to mind is that if the rupee is appreciating and if it is overvalued, in that case I don’t think it is a sustainable thing. An overvalued rupee can only be held for a couple of years. One concern is that as a country, if we make the wrong strategic decisions based on a temporary situation, we may not make the necessary investments and move onto the wrong investments.

Q: What is the role of the investment advisors in stockbroker companies?

Balendra: Essentially it is a client relationship role and an advisor will offer stock recommendations, make sure that trade executions go off smoothly and so on but if you want more in-depth information you would talk to the research analyst covering that sector.

De Silva: One of the issues is the fact that investment advisors are driven by commissions who may take advantage of a vulnerable set of retail investors so that’s the issue and I think there are no quick fixes and easy answers. That’s why the ombudsman role is important so that any grievances could be pitched.

Q: I think this investment advisor role is under spotlight because of some of the SEC action and warnings. Do they increasingly take the role of market-making?

Balendra: An investor spoke to one yesterday and he found out only after that his funds had been used for trading in various stocks he had never heard of – now that is a serious concern which has to be regulated.

Monitoring something like that on a day-to-day basis is not possible but unless a client has given you a discretionary portfolio to manage, really the investment advisor should not be doing that. The stock exchange and the SEC endeavour to regulate that kind of behaviour and activity but sometimes it is impossible to do that effectively.

If funds are being collected to be invested in the stock market and they aren’t being invested in the stock market, that’s like a pyramid scheme, something illegal that the authorities beyond the CSE and the SEC should be looking at.

On the question of ignorant people being lured into the market and their funds being used to manipulate the market, the manipulation is not right and should be stopped and regulated but if they are knowingly giving their funds and they are not knowledgeable of stocks and the fundamentals, all we can do is try to educate them.

Q: The issue of liquidity came up – there has been a proposal to have a minimum float, what’s the progress on that?

Balendra: The proposal was drafted by the SEC, comments have come in from various stakeholders and it will be made a rule in due course.

Q: There was a recent phenomenon where people found opportunity in illiquidity. It’s not unethical but investors saw an opportunity in illiquid stocks. How would you address in terms of investors trying to play on illiquid stocks and make a gain?

Abeykoon: if you take the cases of manipulation and the volatility that we have seen, it’s not a new phenomenon. Especially after a huge surge, you have people who want the good times to continue so they start something to make more money. The problem here is if you take it as a percentage of turnover, on any good day you see the top five turnover stocks, most of them are the ponies – that is something that is unprecedented and should be addressed.

Q: Some of the pony stocks originated because some people got hold of the quantity and started playing and they argue that they create liquidity on the stock.

Abeykoon: This is not something that happens only in Sri Lanka. Even if you look at the US, you will see a number of indictments made for people manipulating stock prices. If you take the experience of other markets, enforcement action does happen. Again volatility is not something unique to us and foreign investors to a certain degree expect that when they come into this market.

There is a role for enforcement and regulators have certain actions to curb excesses. Yes, to a certain degree, markets have to be allowed for this price discovery process to take place and when you have this boom-bust cycle, but it’s happening on a very large scale where prices run ahead of fundamentals. I think what has worried everybody is the scale of it.

Fernando: Regarding these micro stocks, somebody buying shares in an illiquid company is not illegal. What is wrong is after having bought a substantial portion of the shares, if you deliberately try to do transactions to make a false impression, circular trades and such, that is wrong and that law is very well established.

Now that this has become so prevalent, the attention of the regulator got focused on this. The laws to prevent circular trading were always there and this phenomenon is nothing new, it has happened in all the markets. Some people will lose money, the regulator has to get more active and move forward.

Q: How would you support developing foreign investment?

De Silva: As a country, we must look at a new set of investors who would be happy to come and stay. Of course some investors would support the short term liquidity cycles in their agenda but we need to go out to very established investors who are long term in nature and are happy to stay here for the next two or three years, that’s the objective and the country should move towards that.

Q: There is a growing community of Sri Lankans that have enough money in the rural community to really drive the market. There is black money, billions of it and one way to turn in white is to invest it in the stock market. How would you balance this growing base of patriotic base of investors who want to enter but can’t because of various issues?

Balendra: I think we would welcome greater local participation. It’s not that we are regulating to keep away local investors; we are regulating to prevent some of the unethical and improper activity in the market.

Unfortunately a lot of the new retail investors from the rural areas have possibly been mislead and have participated in this recent manipulation. A solution to that is to encourage mutual funds and unit trusts so that the investable funds of these individuals can be pooled and managed by people who have more experience and knowledge on the market. It may be idealistic to assume that we can educate all these individuals by going out there.

Certainly we are not regulating to keep locals out, we would like much more local participation as it is a very healthy development and at the same time, we should have foreigners participating as well. Our domestic savings pool is not going to be enough to drive the kind of GDP growth we are aspiring to achieve.

Q: Why haven’t unit trusts moved?

Chitra Sathkumara: There are limitations with the unit trust industry. Even though the industry has grown in a big way, we still earn just 1.5 per cent as management fees, so we have limited resources to go out and market this and especially educate the small investors but we are trying our best. The other problem we are facing is that we can’t ask bank managers to promote our products because they think we are competing for their deposits.

Q: How can we improve the institutional presence in the market?

Premaratne: Markets have corrected and come to a level where the institutions can actually look at the stocks. There was a time when we didn’t want to even look at the stocks and we were in a selling mode because of the valuation issue but things are now turning, so I’m sure that most of the institutional players are watching for the right price.

The type of volatility that we are seeing in the market today, not only in Sri Lanka but in the global arena, gives a wait-and-see message to the investor on a global level and from the investment point of view, most of the other institutional investors need to take a cut-loss approach in certain areas because some of them are stuck with investments they have already made and they don’t have the funds to go back and invest. If you look at the good companies with good valuations, you can’t complain saying that you don’t have any – there are plenty that have come to the right levels and sooner than later, things should start moving.

Arsakularatne: Apart from the valuation issue, I’m aware of at least one foreign fund that cut back their exposure and withdrew from Sri Lanka because they started focusing on consumer stocks and we don’t have that well represented here.

We have to present a much better proposition to these institutional investors – one way through a framework is to make sure that the economy is well represented, only 20 per cent of the economy is represented in the stock market and there is inadequate coverage on representation of the key sectors of the economy.

Fernando: To say that there is no institutional demand is not true. If you want to bring more money into the market I think new issues at reasonable prices and good size will need to come in to give them something to invest in and then I think the demand will come.

Abeykoon: There is a certain amount of institutional presence in the market - there is a hoarding of cash that’s going on especially when it comes to the corporate sector. Typically when a market is down and valuations start getting attractive, it’s a time when a lot of traditional fund managers go on a fund raising exercise.

There was a regulation brought in recently where foreign investors could also invest in unit trusts, I’m talking about Sri Lankan expatriates living abroad. I know the global situation isn’t very conducive but I think over a six-month time frame, a lot of traditional fund managers should think about how they want to develop a strategy in raising funds. We have made some progress and that this effort needs to be stepped up. I think somebody has to take the lead on that.

De Silva: Corporate investors are not going to hurriedly going to put their money in because the euphoria is out now and the buoyancy is not there so they are moving their funds to real assets, putting up hotels and plants so there is a shift from corporate earnings to real assets which is also a good thing. The task is for us to be affiliated with new stockbrokers, we need international stockbrokers to come in and the CSE needs to facilitate that affiliation.

At the same time we need to portray to overseas every corporate; every stockbroker has to be out there selling Sri Lanka with the CSE supported by every institution and bring in whatever you can in terms of foreign funds.

Q: Do you think the market has corrected enough or you think there is more to it?

De Silva: I think the market is correctly priced at the moment.

Abeykoon: If you take the overall market, there is a bit of downside but some stocks are very cheap right now, there are some very good value buys out there right now.

Balendra: Overall, leaving out these penny stocks, if you look at the top 30 or 40 stocks and look at the average P/E, it is now getting to that point where it is getting comparable to some of the regional P/Es, so I wouldn’t say that the market is overvalued any longer but at the same time, when you have a downturn like this, sometimes the market tends to overreact on the downside but on fundamentals it is starting to get there.

Premaratne: I think you really have to go stock picking that is the way forward and there are good stocks and good companies valued at the right prices but ASPI in general you have to be cautious as it is very artificial still because some crazy stocks are driving it up and down. Fernando: When you say market, I break it into two – you have the real market and the pony market. The pony market has to crash dramatically; there is no question about it.

The real market is at good value now, good stocks but it could come down a little bit more because of the overshooting effect but this is the time institutional investors need to start getting in because when it turns it gets too late and then you start chasing stocks.

Q: Although everyone says buy, there is no money in the market, there are no buyers even for JKH at the moment, how can that be fixed?

Abeykoon: Yes, certain people are stuck again; most of it is on the retail side of things. If you take the corporate accounts, there are people who have steady cash flows and they are building up their cash positions. I don’t subscribe to the view that there is no cash in the market, I think there is a certain amount of hoarding of cash going on right now.