Features

Consolidation and cohesion seem to be talk of the town

26 Jun 2014 - {{hitsCtrl.values.hits}}

earing mid-year 2014, the Colombo Stock Exchange (CSE) has gained 5.6 percent with the All Share Price Index (ASPI) advancing by 352 points. Despite marginal volatility, the activity levels or more commonly described based on average daily turnover has been maintained above the Rs.1 billion mark.

The last two weeks of trading in the month of June also somewhat mirrored the yearly performance with the average daily turnover recorded at Rs.1,016 million with the ASPI gaining 15 points (or 0.25 percent).

Foreigners continued to be the net buyers while purchasing stocks to the tune of Rs.3.7 billion and selling Rs.2.2 billion worth of stocks. Also year-to-date, 2014, overseas investors have been net buyers in Sri Lankan listed stocks with Rs.5.2 billion of net purchases.

Creation of a vibrant capital market would be possible only with cohesion of the market intermediaries, namely; the regulators, the exchange, depository system, brokerages and IT providers

Foreign investments
I believe foreign investments are seeping into the CSE primarily due to the valuation plain we are in comparative to the other frontier markets. The stocks listed on the Colombo bourse are trading on 13.2x trailing four quarterly earnings and despite not having a significant discount to other peer markets we are still having a slight advantage.

Given the difficulty in arriving at a consensus on forecast earnings and respective forecast price earnings multiple (forward PE), according to my thinking, overseas fundamental investor places more emphasis on the most recent reported earnings and the resultant price multiple, hence, focusing on the latest four quarterly earnings.

Thereby, armed with these reported numbers, the fundamental investor tries to ascertain a growth outlook for the market or the selected stock portfolio. And this is where the risk lies for continuous net foreign purchases!

Our growth outlook for corporate profit is somewhat lacklustre and other frontier markets are having earnings growth estimates which are many folds higher than ours. Therefore, we are still attracting foreign investments into the listed market mainly due to the macro positives, which are the strong 7 percent or more gross domestic product (GDP) growth (which is better than most other comparative markets), commitment to narrow the fiscal deficit, low interest rates, reported single digit inflation and some initiatives towards developing smooth international trading.

The expectation is for macro positives to trickle down into the private sector and more importantly profit growth for listed companies. However, this result seems to be taking an awfully long time and the risk would be that the prolonged wait by the foreign portfolio managers may result in waning patience. And if the outlook for some other competing frontier markets begins to look up, the Colombo bourse may soon lose the position in the global portfolio managers’ investment radar.

Then the question could be raised, why such importance is being placed on the foreign investors at the CSE. The answer is simple, foreign money accounts for around 40 percent of market turnover on average and has been the cornerstone of market stability in Colombo not for a few years but for many decades.

Also, the elected government irrespective of political parties would also benefit from a vibrant stock exchange, since the listed market is considered to mirror the economic ups or downs of the broad economy, hence, the first place of reference for any investor looking at Sri Lanka as an investable destination.

These are common benefits of a stock exchange in addition to the basics of providing an additional investment destination/class to the public and creating an alternate market for companies to seek capital and/or further opportunities of mergers and acquisitions.

Therefore, for an economy functioning on capitalist or liberal thinking, a stock exchange is a necessity and the more robust the exchange, more vibrant the country’s economy is perceived to be. So, given these positives, it is hard to sideline the importance of an equity exchange to a country. Nevertheless, thinkers more inclined to protectionist thoughts have the opinion that local retail and corporate investors need to be pushed into the market so that more transactions would be triggered by local investors or traders and reduce the market share, which the sophisticated foreign investors would have on the CSE.

Reaping best benefits
Again my thoughts differ, since I believe the stock exchange is a market place like any other with the only difference of transacting listed securities digitally. As in any market, the efficiency of the transactions and volume would depend on demand and supply, which would in return be driven by the profit motive and requirements of the buyers or sellers.

Therefore, lesser the intervention, more efficient and robust the market would be. To reap the best benefits from a market, it should allowed to be free of external intervention and any forceful direction. However, by no means do I say that regulation is not necessary; it is needed since all financial transactions should be carried out according to the established legal framework.

But external intervention should stop at regulation and all other matters should left to be decided by the market forces. Creation of a vibrant capital market would be possible only with cohesion of the market intermediaries, namely; the regulators, the exchange, depository system, brokerages and IT providers. The regulators should focus on regulation and policy directives of the capital markets to create efficient transactions and improve the transparency and quality of timely information dissemination by the listed companies.

Marketing activities should be left to other market intermediaries, to avoid duplication of resources and wastage despite how sincere the motives are. The role of a stock exchange would have some differences based on the nature of the exchange, i.e. whether it is mutual, demutualized or a government-owned exchange. However, the primary role would be to facilitate efficient and low-cost trading, assist the regulators with regulatory aspects, increase the number of meaningful listings, given the Sri Lankan context educate the public, advice and monitor the financial reporting aspects of the listed entities, etc.

Whereas the depository house has the primary responsibility of holding listed securities on behalf of the investor and maintain complete confidentiality of trades and investment information. The brokerages would be profit-seeking organisations and hence they are motivated to invest in quality resources both human capital and infrastructure, produce quality research, marketing of listed securities, conducting roadshows to attract investors, etc.

IT service providers also have jumped up in the hierarchy of importance given the high dependence on IT solutions in a digitized market place. Therefore, the ability to obtain the services of a few high-quality service providers who are capable of addressing the needs of investors, brokerages and the regulators is vital for the efficient running of capital markets.

Foreign money accounts for around 40 percent of market turnover on average and has been the cornerstone of market stability in Colombo not for a few years but for many decades

Window of attraction
Returning to the point of market equilibrium, I think its futile trying to alter market forces and attempt to drive stock market performance in a desired way since such actions are not sustainable. What is plausible is to let each market intermediary work on their responsibilities limiting duplication and resource wastage while attempting to increase efficiency and liquidity. If such practice is followed in time to come, the Sri Lankan capital markets would become more vibrant and a window of attraction for all classes of investors.

The brokerages have been the key driver of capital markets and that norm is an established fact. In Sri Lanka we are now seeing stable average daily turnover levels of Rs.1 billion which is good, but to sustain an industry with 28 brokerages we need to see at least double the amount of trading value.

Market turnover cannot be engineered and increased but will be an outcome of the market forces and the economic environment. Listed companies need to record strong profit growth, free float of listed companies should increase, large corporates with sizable market capitalizations should be freshly listed, the market should be well researched by the brokering houses, etc.

Therefore, in my opinion, consolidation could take place in the brokering industry as well. Despite the losses stomached by the brokerage owners, this will be a positive for the overall industry since resource wastage would be limited, stronger brokerages would survive and drive the industry.
However, with the interest rates most likely to remain low for a prolonged period the activity levels and performance of the CSE could look north. Albeit a full throttle market rally may not be on the cards but a more measured market growth, since the corporate profit hasn’t been as robust as expected to give the additional thrust needed for a buoyant index upswing.

Features

Consolidation and cohesion seem to be talk of the town

Creation of a vibrant capital market would be possible only with cohesion of the market intermediaries, namely; the regulators, the exchange, depository system, brokerages and IT providers

Foreign money accounts for around 40 percent of market turnover on average and has been the cornerstone of market stability in Colombo not for a few years but for many decades

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