Insights into putting money in Colombo’s stock market
Investing in the Colombo Stock Market can be an unfamiliar business for a new investor, who has not had prior experience in stock markets. A number of elements need to be considered when you turn your mind to the prospect of investing in shares.
Process of investing in securities through the CSE
Investing in securities listed in the Colombo Stock Exchange (CSE) can be done by opening a brokerage and Central Depository System (CDS) Account through a member or trading member of CSE, which is done Free of Charge (FOC). Once the account is opened the investor will be assigned a Registered Investment Advisor (RIA) to buy and sell securities listed in CSE based on the investor’s instructions.
Costs related to investing
The brokerage fees charged for buying or selling shares up to Rs.50 million by a stock broker in the CSE is fixed at 1.12 per cent of the transaction value. Transactions cost above Rs.50 million is negotiable and the minimum brokerage fee is 0.6125 per cent of the transaction value.
Gathering information through credible sources
The primary sources of information, which can be accessed free are investment research reports, daily commentary, flash investment ideas and earnings calls published by the stock broker. In addition, the investor can download and review annual reports and quarterly financial statements of any listed company and CSE Daily (provides turnover, trading volume by stock, foreign trading, dealing by directors and CEO’s of companies, announcements, etc) from the CSE website FOC.
Further, research material of the S&P top 20 listed companies published by Copal Amba is available to download from the CSE website FOC. It is imperative that investors follow these published research material and make their own investment decisions. Investors need to be financially literate, have the time to read and understand company research reports and financial reports to invest wisely. If they are too busy with their job or other responsibilities and do not have the time to manage their own investments or do not know enough about investing on their own, then they need professional investment advice.
Obtaining professional advice
Choosing a stock broker firm that helps you to build your wealth is the single most important decision you will make as an investor. It doesn’t matter if you are a beginner or have been investing for many years; it’s never too early or too late to start asking questions. Identify and prioritise what’s important for you. Find out what kind of investment advice and research support you require. Get referrals about your Investment Advisor. You can find out from other people about the broker they use and why they have selected them, it is better to choose someone whom you have heard good things about. Find out whether the broker firm adheres to a high standard of ethical behaviour and fiduciary responsibility. Ask them if the firm or their investment advisors have been disciplined by the Securities and Exchange Commission (SEC) for unethical or improper conduct.
Think about whether the investment firm communicated candidly with you about investment risks; during your initial consultation with the firm’s representative, did the representative provide you with a clear understanding of each investment option’s risks and rewards? Ask the firm about the safeguards they have put in place both from a security of your information and risk management point of view. Does the investment firm maintain a risk management system, information security and controls to protect your funds and confidential information?These questions are not exhaustive. They will help you identify a stock broker that will best meet your personal investment objectives.
Main advantages of investing in equities
The supply and demand of securities determine the price of the securities traded on the secondary market. The main advantage of investing through the secondary market is that the investors get the opportunity to buy and sell securities to achieve higher returns than from fixed deposits (FDs)over the long term. The price of securities in the secondary market fluctuate based on how investors perceive future earnings of the company, local and global socio-economic and political factors affect security prices.
Smart investors can take advantage to buy undervalued securities due to market fluctuations and sell the securities at a profit when they go up in value. Second advantage is that, an investor can buy securities that pay good dividends and create a stream of income irrespective of market price movements. Third advantage is that, all securities listed in the CSE are fairly liquid from a retail investor’s perspective and therefore can be sold and converted to cash if required in an emergency.
Securities vs. Fixed Deposits – The risk return objective
Investing in securities involves taking risks as security prices can go up as well as down and therefore is subject to uncertainty of returns. Hence an investor should be prepared to accept volatility or change in the value of the principal invested in securities and dividend payments. The equity investor is usually compensated for this uncertainty or risk by better returns than any other asset class, where he will see his investment value grow over time, provided the investor follows prudent investment principles and invests smartly. People invest in equities of companies and undertake entrepreneurial activity as there is tremendous long term value creation in properly governed companies.
The capital market offers the means to participate as an owner in the growth of the companies that make up the Sri Lanka economy. Investing in FDs is perceived as low risk by most Sri Lankans as the principal invested does not fluctuate in value and both principal and pre-determined interest for the period is received at maturity of the FD. Although the principal and interest of a FD do not change over the term of the deposit, the investor still bears the default risk or the bank or finance company being unable to pay back the principal and interest. Further, the investor in the FD bears inflation risk or erosion of purchasing power of money over time.
Leveraging to maximise returns
Leveraging allows experienced investors to buy more stock than they are able to, by pledging stocks in their portfolio and borrowing against it. Trading in shares using leverage, (called margin trading or broker credit) was quite popular during the bull runs of the stock market. The main advantage of trading using leverage is that the returns can be far greater when stock prices go up over short periods of time as the interest you pay for borrowed funds pledging stocks in your portfolio is lower. However, leveraging is inherently risky, if the stock prices fall significantly the margin provider or broker who provided credit will force sell to cover the funds lent and the investor can lose.
Risk aspects of margin trading
When a stock price goes down, buying on margin can work against you. If the value of a stock goes down below a certain level, the margin provider reserves the rights to force sell the stock to cover the loss. This could accelerate the price drop even further. If the situation intensifies the investor may end up losing his whole portfolio. Some of our local investors learnt a bitter lesson in the recent past when they lost all their money due to margin calls.
Returns through equity investments and other asset classes compared
Historically, equity investments have given better returns compared to other asset classes in Sri Lanka as depicted in the graph. Rs.10,000 invested in1999 in the All Share Price Index (ASPI) has given a return of 18.5 per cent over a 15 year period compared to FDs about 11 per cent, land around 10 per cent and Gold around 9.8 per cent over the same period.
(This series is a collaboration between the CSE and CFA Society Sri Lanka to enhance investor knowledge in capital market investing. All posts are the opinion of the writer. The writer is the current president of the Colombo Stock Brokers Association, CEO/Director of Candor Group of companies and is the first CFA charterholder).