Karl Marx’s quote has more relevance in today’s global capital market than when it was first written.  If we were to critically review the recent turn of events global and Sri Lankan capital markets, the common thread and the precursor to the downturn and the subsequent collapse is getting into areas with no proper knowledge. [...]

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The Sundaytimes Sri Lanka

Capital Markets: Looking ahead

Upul Arunajith
“They don’t know it, but they do it “– Karl Marx.
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Karl Marx’s quote has more relevance in today’s global capital market than when it was first written.  If we were to critically review the recent turn of events global and Sri Lankan capital markets, the common thread and the precursor to the downturn and the subsequent collapse is getting into areas with no proper knowledge. Sub-prime mortgage crisis is still fresh in our mind. It is no more a secret that, believed to be Wall Street’s top brains were behind these credit default swaps but they failed to measure the inherent risk.

In Sri Lanka, the capital market over the years has had a roller coaster ride. From its lackluster performance the market spiked to be one of the best performing markets in the world. The superlative “best” was short- lived. In more recent times the EPF investments in the capital market and the reported mix bag of returns has been widely criticized. The Central Bank was swift to defend its position.

Then comes the role of the capital market regulator, the Securities and Exchange Commission (SEC). The investor community collectively point fingers at the regulator alleging the market is over-regulated. Not stopping at what they do good with inborn dexterity, finger pointing then they seek political leverage.  They then make futile attempts to conceal behind the “patriotic” banner and call the statutory bodies “unpatriotic” merely for discharging their duties.  In these situations, what is right transcends who is right.

Politicisation
In 2005, following President Mahin Rajapaksa’s victory for no apparent reason the market pulled back. If the market functioned on solid fundamentals then we should not have seen what we saw in 2005. The stock market must be a level playing field. It’s not the space for few manipulators with political patronage. Politicising of all forms will never bring any progress and detrimental to all and in particular to the manipulators. Politicization, thwarts and negates fair-play and interest of the greater majority. Without ascribing a negativity let’s strive to find out as to why they resort to political patronage. Solution to the current crisis lies in the answer.

Education     
The key to finding a solution to a problem is to acknowledge the very existence of the problem. Trying to deflect is not going to lead us to finding a solution to a problem. In this connection, thus far what is happening is the investor community taking the SEC to task – barking up the wrong gum tree for sure.

To be successful in any endeavour, the application of appropriate knowledge is the key. Having knowledge alone will not take anyone to the goal. It’s the application of your knowledge that will bring the desired results. Empirically, it’s evident that there is a knowledge gap when it comes to capital markets. This lack of knowledge among the larger investor community creates fertile grounds for fly-by night operators to enter the space.

It was recently revealed that there are 160,000 accounts in the National Savings Bank. In the stock market we see only 10,000 capital market actively traded accounts. This disparity is clear reflection of lack of capital market knowledge. Most will not know the difference between “Saving” and “Investing”. Fundamental as it may seem this lack of investment knowledge across a wide spectrum of investors was further validated in a survey undertaken by Brondesbury Group.

There is a mismatch to apply the conclusions to Sri Lanka given the conservative society. For the most part, money is saved not knowing the impact of inflation. How inflation will erode the potential purchase power, risk and reward, capital gains and dividends, management expense ratios as it would apply to mutual funds is off limits to most investors.  Investors now got to depend on investment advisors.

Investment advisors in turn would bring in technical jargon and further confuse the prospective investors. We saw how some “investment advisors” offered high returns and then disappeared in to the thin air. Proper education is one counter measure to stop the investors from being devoured by these advisors. A savvy investor community will question, have realistic investment objectives and not fall a prey to wrong advise.

Equally important is the capital market rules and guidelines, Investment advisors must be qualified, be ethical and above all be compliant of the capital market rules and guidelines. Most rules are violated due to lack of knowledge. Investment advisors should know the client well and know the investment products well. In any investment plan, advisors must assess the suitability of products before the product is sold. Even in the event a potential client wants to invest in a product but if it’s not in the best interest of the client, it’s the duty of the advisor to advise the investor accordingly. That stated, capital market development initiatives saw a growth in the IPO. Most IPO were oversubscribed.  This leads us to question if IPO are the space of average investors.  Most IPO’s takes a tail spin in the secondary market making IPOs a high risk investment suitable for accredited investors only.

Economic Value Addition (EVA)   
DDM (Dividend Discount Model) is an equity valuation model used widely feeding into Price-to-Earning. A more effective alternative to DDM is the EVA (Economic Value Addition) model that factors in superior management and the management’s ability to add economic values and bring comparative advantages and create future cash flows. EVA is related to NPV (Net Present Value) of future cash flow discounting technic. EVA measures the annual management performance by comparing the net operating profits of the firm minus tax to the cost of capital plus cost of equity. If the Net Operating Profit after tax exceeds cost of funds, then the firm has a positive EVA. It will be prudent to explore the possibility of developing a scale to value suitability of investments in particular IPO’s and similar investments made by EPF.

(The writer is a capital and derivatives markets’ specialist based abroad)




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