Assessing capital market

Take a fresh look
Today -- about eight years after 1996 -- we now have improved versions of rules relating to public issue, right issue, acquisition, mergers and so on. On the secondary market, surveillance is more active and particular than before. These developments, that we appreciate, are actually the fundamental requirements that are in place today resulting from the continuous efforts of the government and multilateral agencies.

The capital market plays various roles in an economy. It acts as an intermediary between surplus units and deficit units of the economy and facilitates savings into investments. By also providing liquidity of these investments, the capital market ensures optimum allocation of resources. All these activities make it the engine for the growth of the economy. The financial market is organised into money market and capital market. Financial instruments have less than one-year maturity trade in the money market, while instruments have more than one-year maturity trade in the capital market -- though certain exceptions exist. Let us take a fresh look at the market to analyse the reasons behind this underdevelopment.

The access to the information remains a major problem in the market. While handful of institutional investors may enjoy certain benefits since they have an investment unit manned with qualified officers, nothing exists for retail investors. And, in the absence of independent research houses, retail investors primarily focus on advices given by their brokers, and rumours. This is frightening and it often leads to enormous losses for small investors who are vital for a low-income and pre-emerging market like Bangladesh. Filtering of information among different types of investors may leave scopes for manipulation, this assumption has been proven in 1996 at the cost of many individuals and households.

One of the biggest disadvantages of our capital market is the absence of a long-term debt market. Without a proper long-term corporate debt market, the dependence on bank financing to facilitate investment is very high. Also, it creates fundamental imbalance in the ratio of equity to debt financing in the economy. All these results in the market not having adequate number of fundamentally sound scrips and exert rampant price distortions in the market. Authorities are enforcing companies to list in the stock market. However, it should not be the ideal scenario. In that case why not publicly held companies list themselves, why not privatisation takes place by listing through stock market or government releases some of stakes with the very profitably run multinational companies? Authorities should think about introducing the government debt instruments to transact in the capital market. That will help in developing a market yield curve and bring in transparency in the valuation of debt and equity scrips. A portfolio investor will then have the option to reduce his average portfolio risk by adding these risk-free opportunities or vice versa.

An estimate suggests that the ratio of institutional-to-retail investors is between 20-25 per cent, this is considered low for a developing market like ours. Institutional investors bring long-term commitment hence stability in the market. The presence of institutional investors also ensures better level of valuation due to their specialised skills. While we do have public sector as well as private sector institutional investors in the economy, proprietary investment from these institutions is not significant -- other than Investment Corporation of Bangladesh that was created in 1976 and currently manages several mutual funds.

Transparency builds trust
The level of corporate governance of international standard is lacking. Multinational corporates and institutions operating in Bangladesh often adhere to very high international standard compliance regime. Parent companies of most of these corporates and institutions have their scrips listed in developed markets. Unless the local market adheres to and effectively enforces a standard corporate governance system, there will not be a level-playing ground for international business houses vis-à-vis local operators.

The supply of securities can be increased if the SOEs are allowed to operate through stock exchanges. Floatation of SOE scrips is expected to expand the market by a couple of times. Corporatisation of SOEs will bring in transparency as well as confidence on the government financial system. In a more developed market, institutional investors such as merchant banks, commercial banks, insurance companies, are major traders of securities. We need enforceable and more effective laws and rules to attract foreign institutional investors.

Inadequate disclosure requirement and culture of family-owned conglomerates deter the expansion of corporate governance into the local industry. The regulators need to play an active role in removing the bureaucratic bottlenecks and promote rules that provide incentives to these groups of companies to list.

Fair valuation is the key
An important aspect for capital market is reflection of fair value of scrips. We find analysis touching the rise or drop in stock prices on a post-facto basis, but investors would be glad to receive projections and recommendations from research analysts. This is not adequately present in the current scenario, and due to this reason the market is not receiving attention of an important segment of investors, both foreign and local. Quality analysis needs to address this valuation issue in a more pro-active manner. The independent analysts should raise the flag when scrip is overvalued or undervalued, the intrinsic value of a traded security should be covered in the research paper. Investors are perhaps depending much on speculative analysis resulting into volatility in the market as opposed to fundamental analysis, which could attract more stable long-term investors who are sure about their investment tenure and expectations.

Given the developments in the regional capital markets, we believe, it is now a matter of time for Bangladesh to initiate privatisation through capital markets. SOEs that have profitable track record or have potential for turn around shall be properly valued. Privatisation through public floatation creates the most public awareness, widespread ownership, and this process can be easily used when large amounts of capital need to be raised. We need to develop capacity to price these issues by using acceptable valuation practices so that the subscriptions are acceptable to international investors.

In the final analysis, the Bangladesh capital market still has a long way to go. It is growing, but the pace needs to be faster. With the support from government and multilateral institutions for capacity building this market has every possibility to improve. We are yet to have in place several missing parts of the vital market infrastructure, and valuation and appropriate rules are essential segments of this expected infrastructure.

Mamun Rashid is a banker and director of Chittagong Stock Exchange.