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Month to date, May 2014 has been rather encouraging for the Colombo bourse with the All Share Price Index (ASPI) gaining 57 points (or 0.9 percent) while recording a healthy average daily turnover of Rs.1.4 billion. However, the average daily liquidity of the market has been just below the one billion mark at Rs.950 million when excluding the 30 percent acquisition of Expolanka Holdings for Rs.6.3 billion by a Japanese-based firm.

Further, market performance YTD 2014 remains positive with the ASPI gaining 5.2 percent (or 313 points) and recording an average daily turnover of Rs.1,035 million. Foreign trading dominated the Colombo Stock Exchange (CSE) in MTD May, with the overseas investors accounting for over 50 percent of turnover followed by the local HNWIs.

Sporadic market participation by the local institutions were also visible though nothing worth boasting about. Overall the foreign investors were net buyers during the month, purchasing stocks worth of Rs.11.8 billion. Net foreign purchases amounted to Rs.9.1 billion and even after excluding Sagawa Group’s purchase of 30 percent Expolanka for Rs.6.3 billion, net foreign buying was at Rs.2.8 billion.



MSCI Frontier Market Index
Sri Lanka being included in the MSCI Frontier Market Index along with 28 other countries has been a strong magnet for attracting foreign investment funds to our country. This has enabled us to maximize on the current flow of global equity investments into de-coupled frontier markets having less correlation to the developed and emerging markets.

However, this global frontier market index is up for revision and indications are that couple of countries may exit into the Emerging Market grouping while a few fresh members would be added.

Market performance YTD 2014 remains positive with the ASPI gaining 5.2 percent         

Hence, our competitive landscape would change and based on the weighting Sri Lanka has on this MSCI Frontier Market Index we will have to compete against the other group countries in attracting foreign equity investments while the pole position would undoubtedly go to the nation which has the strongest growth prospects, good transparency and improving fiscal discipline.

Also the capital market participants such as the stock brokering firms have done a mammoth task of promoting Sri Lankan equity markets over the past decade or more and building long-standing relationships with foreign clients and partners. Global investors place high importance on fundamental research production and the companies that have invested in building research capacity and conducted frequent roadshows during the past decade or so had done an ardent service to the local capital markets.

However, the current market turnover of just over Rs.1 billion per day is not sufficient to sustain a 28 firm stock brokering industry, hence I believe an industry shake-out could happen sooner than later. Hence, for a market which trades below Rs.2 billion a day an industry with 15 odd brokering houses would be a sustainable model which would avoid inefficient resource duplication and build effective capacity.     

Coming back to trading activities at the CSE, YTD participation levels of the local institutions has been lackluster and contrary to the expectation of a boost in investments. Local investment firms are still undecided in their path of action and has been mainly spectators watching the trading of foreign and local HNWIs.

Global investors see value in the CSE and they are confident to take a medium to long-term view buying stock to hold for around two to five years while the HNWIs have become the facilitators of liquidity taking up the role of market makers. It is beyond my comprehension why the local institutions do get excited about the CSE only during a market rally and do not see opportunities and/or value when the market or stocks becomes sluggish or moves sideways.

A move away from the equity markets are understandable if alternate asset classes such as fixed income has higher yields but with the interest rates heading further south and the Central Bank of Sri Lanka confident of sustainable low interest rates over the medium term the reasoning for the local institutions to have limited participation in equity markets lacks rationale.

It is rather disappointing that we do not learn from past events, since this is not the first instance that the overseas and local HNWIs were farsighted to understand the economic and market cycles and acted accordingly to accumulate stock during sluggish market situations and realized steep gains by offloading during a market rally.

And more often takers of these stocks at higher multiples were the local institutions and the retailers. So at least now the local institutions and the retail investors should revisit their investment strategies and pick fundamentally strong counters with relatively attractive multiples. Also having a medium to long-term focus does not mean that we cannot realize a short-term gain while simultaneously boosting market liquidity.

The beauty of having a medium-term view on fundamentally strong counters are that if the stock prices rally in the short term, exiting with a significant gain would be an added bonus with limited risk freeing up cash for further stock picking. Trading on stocks which are considered fundamentally strong and are the favorites of the global professional investors is a time tested model with limited downside risk which has proven successful for many HNWIs.

Therefore, given these opportunities the only reasons I can think of for the local institutions to still shy away from CSE investments is that they are strapped for cash either because they have invested in property or other unlisted businesses and/or facing redemptions at a higher rate than they are attracting funding.



Improving liquidity at CSE  
Improving liquidity at the CSE has been a continuous challenge for all market participants for many years and many steps have been taken to improve the situation though still much has to be done. In the past there existed a school of thought stating Sri Lanka is expensive to trade and the transaction fees should be lowered to entice foreign investors and hence the brokerage charges were reduced.

But in hindsight the reduction on transaction fees has not derived the expected boost in liquidity nor foreign investments. The CSE is a small market with a market capitalization of just US $ 20 billion and for transaction fees to really make a dent in investment decisions the market need to be at least US $ 100 billion with many Exchange Traded Funds (ETFs) having narrowed in their focus.

Overall the foreign investors were net buyers during the month, purchasing stocks worth of Rs.11.8 billion

So, in my opinion, we were ahead of time in reducing the transaction fees while ideally we should have waited till the Colombo bourse matured and gained scale. Also when investing in smaller frontier markets the transaction cost has less significance in the mind of the global investor since frontier markets are countries which usually have high sustainable GDP growth rates which would compensate for the high transaction costs.

Also in markets everyone participates to generate profits, and no one owes anyone favors. So, if the Global investment funds are investing in Sri Lanka, it is not because of lower transaction fees but because they see potential and expect to generate significant gains from their equity investments in Sri Lanka. Then there was the focus on increasing the number of listed companies and thereby increasing the market capitalization and liquidity levels.

At the outset this seems a rather correct course of action though there are limitations which we need to address. Despite the increased number of listings, the market capitalization levels and daily liquidity levels have been stagnant and is also lower than in the years 2010-11. It is agreed that more the listings it’s better for the market but we also need to be mindful of the size and quality of the listed companies.

Equity research provides the basis for attracting professional investors to the CSE and improves the transparency and the efficiency of the equity markets. However, research production on small sized, low cap listed entities with rather poor free float is limited since it is impractical to provide research coverage on such listed stocks since the number is many.

So, if we keep on adding more and more similar stocks to the CSE, it would just widen the gap between the percentage of the market which has intense research coverage and the rest which would not have similar coverage. Professional investors both foreign and local would be enticed with research coverage and higher the percentage of the market been routinely researched would be a key driver to attract new investors.

However, this becomes a catch 22 scenario since most of Colombo bourse is hardly researched due to its size and minuscular free floats. While the only possible solution been to attract larger corporates to list which would positively affect the total market capitalization in a meaningful manner.



Minimum public holding criteria
The regulator is currently in the process of introducing minimum public holding criteria with the expectation of increasing liquidity. In my opinion this initiative could be further bolstered if there could be a cohesive effort to provide some incentives for listed companies to remain listed and unlisted large scale companies to be listed.

Some of the basic motivators for corporates to list could be the provision of reduced corporate tax rates if they meet certain criteria of size, free float, etc. Lock in Board of Investment (BoI) benefits for new large-scale businesses with requirements to list while the existing BoI companies could be considered for extended benefits, provided they list.

Such initiatives could boost overall market liquidity levels while improving transparency. Also giving prominence to practicality, I believe the CSE should revisit the creation of their indices. ASPI is the broad index for the overall market while the applicability of the S&P SL 20 is limited. The latter index was created to focus on the blue chip, high liquid counters and consists of 20 stocks. However, the current S&P 20 index consists of a few stocks which hardly trade and when they trade it is as a result of a related party group transaction, while the only reason I can think of them been included in this index is due to their market capitalization.

Nevertheless, this nullifies the purpose of such an index, while I believe this index should ideally have 35-50 names with liquidity criteria, market capitalization, free float, disclosure requirements and past three to five years profitability also considered. And hence, such a meaningful and practical index would provide some guidance to the local retail investors with a group of stocks which are considered to be fundamentally strong, lower risk and sufficiently liquid.

Coming back to the discussion on the market in May, the CSE is attractively valued at 13.3x trailing four quarterly earnings. While a few years back we looked at the market multiples and thought it to be attractive only if it is below 12.5x or so, but now the environment has changed which requires us to rethink our basis.

With a few companies being in the red and some finance companies going through a difficult period creates a drag on broad market earnings and pushes up the multiples. Also macroeconomic landscape has changed since 2009 and warrants higher growth possibilities with reduced risk which in turn justifies higher multiples.

Therefore, given the current growth and risk profile of the country a one-year forward market multiple of around 14x is also justifiable. However, the consumption led growth has seemed to wean with limited capacity building and job creation in the private sector which could create some challenges in the future and the market to move sideways.