Sideways move continues with strong foreign buying

13 June 2014 05:13 am Views - 2246

Foreign money seems to be flowing into the Colombo Stock Exchange (CSE) listed equities with Rs.3.1 billion worth of shares been bought by overseas investors month to-date in June, while the net foreign purchases thus far for the month was Rs. 2.6 billion.

This was on the backdrop of market turnover or activity levels heading south with the average daily turnover per day nudging below the one billion mark to Rs. 890 million in June, down from the year to-date average daily turnover of Rs. 1 billion.

Therefore despite the boost in foreign activity the market otherwise remained silent with the All Share Price Index (ASPI) gaining by just 23.6 points (or 0.4 percent) in June, though year to-date the main index at the Colombo bourse had gained 319 points reflecting a 5.3 percent increase.
Another fact which remains an attention grabber is that the net foreign purchases into the listed stocks at the CSE are mere portfolio investments and not strategic in nature.

Why no local interest?

However interesting question remains, why are foreigners buying Sri Lankan listed stocks and why aren’t the locals not doing so?

Are the foreign portfolio managers seeing something we locals are missing or is it that they are over estimating the growth potential in Sri Lanka?
 My take is that foreign portfolio money is landing on our shores since these professional fund managers would tend to look beyond the short term headlines and are normally patient in their investments.

The investors who are currently investing in the CSE are more medium to long term focused and believe the reported GDP growth would gradually trickle down into the overall economy and be visible on corporate earnings growth in the listed equities in time to come. Hence these investors are willing to stomach the wait and expect for much more market upside given the low interest rate scenario and government investment drive to create the path for stronger private sector growth.

Are the foreign portfolio managers seeing something we locals are missing or is it that they are over estimating the growth potential in Sri Lanka?

However if corporate sector earnings growth fails to materialize during the coming 12-24 months the investor patience might wane and we may see a sharp outflow. Also the noise created by short term news items are less likely to deter the current group of foreign portfolio managers narrowing in on Sri Lanka, given their longer term view, though the scenario would be different if larger high intensity hedge fund operators commence investing in Sri Lanka.

The upside of having hedge fund operators active in a listed market is that the high frequency trading would boost market turnover though creating significant index volatility and sensitivity to various news bursts.

Frontier markets

The focus on Frontier Markets in which Sri Lanka is grouped is on the rise, since the track record for risk adjusted performance is high, less volatile relative to other developed or emerging markets and provides better diversification possibilities in economies which are correlated only to a lesser degree. This overall buoyancy towards Frontier Markets is nevertheless a key driver for Sri Lanka also to attract investments. Albeit these positives CSE’s market capitalization and weighting in the overall Frontier Market index is rather small and Sri Lanka doesn’t seem to be the most favored investment destination.

Larger economies, trading at lower multiples with stronger growth outlook would climb the pole position in investor preference. Fine examples would be countries like Pakistan and Kenya. Pakistan, despite facing terrorist attacks during the past few days are continuing to attract strong foreign portfolio investments, since the market valuations are attractive, the corporate earnings are likely to grow by over 20 percent year on year and the government is doing IPO’s and listing partial stakes of state owned enterprises.

Kenya on the other hand is attracting many multinational companies to set up operations in their country, leading to a sharp increase in foreign direct investments. Global portfolio investors see favorable government policy, publicly listing government assets and foreign direct investments by multinational companies as key indicators for future GDP growth, better transparency and capital market upside. Hence learning lessons for Sri Lanka from our neighbors’ and similar frontier economies.  

 Therefore Sri Lanka’s case would not be the best out of all frontier markets but it is still good, and global frontier market investors are accepting that. But why is local investor sentiment still weary? The main drag could be the losses faced by local retail investors during 2012-2013 which are still casting dark shadows on their sentiment. The cost increases of ordinary imported consumption items, electricity tariff hike, the overall feel of cost pressures for the urban consumer and a reduction in disposable income has created dents in business sentiment in the city which is trickling down into the broad economy.

Private sector sidelined?

The government is carrying out their heavy infrastructure investments which is required and good but the lack of established private sector participation in similar activities are bringing about the questions of whether the private sector is sidelined! Also the increases in taxes and various import duties are not favorable for our terms of trade and is resulting with a sharp blow to business sentiment. Overall my take is that state led economic growth is real and good since the government would provide direction for industries to grow.

What is now required is providing more freedom for the private sector to invest and expand, by way of transparent/common tax reductions and investment incentives which would in turn result in corporate sector job creation and profit growth.

Currently the financial sector which is facing situations of excess liquidity and slow loan growth could also return to equilibrium if the business sentiment is improved and this positive psychology would transform itself in to equity market growth.

Sri Lanka’s case would not be the best out of all frontier markets but it is still good, and global frontier market investors are accepting that

Therefore with limited alternate investment avenues the local institutions, HNWI’s and retail investors should seize this opportunity and start to accumulate listed equities with strong fundamentals, but not targeting to make capital gains in the short run instead have a decent time horizon. Ideal time to accumulate equities in economies which has strong growth potential is when the markets are moving sideways and not much headlines are made in capital markets.