Capital Market Outlook – Remainder of 2011

If investors and general public are fed up by the vagaries of the capital markets, they may take solace in the fact that this has been the bane of investors for the last five centuries. There is chronicled history about share market excesses and subsequent demises, which left large impact on the mainstream economy and state affairs. Here is an excerpt from Daniel Defoe on share market manipulation, written three hundred years ago –

Some in clandestine companies combine;
Erect new stocks to trade beyond the line;
With air and empty names beguile the town,
And raise new credits first, then cry 'em down;
Divide the empty nothing into shares,
And set the crowd together by the ears.

Sounds familiar in the Bangladesh context? It must have because we saw a similar phenomenon once before in 1996. The cautionary signals were all there, but still people got carried away and chased unrealistic returns. One does not have to go too far to find “air and empty names”; there were plenty in the likes of CMC Kamal, Chittagong Vegetable and Summit Alliance Port. The exact reason for this year's stumble is not known; it could be tighter control of credit by the central bank, tweaking with margin lending by the SEC, or talking down of share prices by manipulators who subsequently lost control. Or it could simply be the loss of investors’ nerve en masse, which sooner or later happens in an overheated market.

We all know what followed next. A major correction in January 2011 naturally caused investor anger and street venting of such anger and frustration. A complicit government, which has been repeatedly alerted to such an event, produced further hot air in pronunciations, declarations and accusations. A government probe committee came out with surprisingly candid, honest and informative account of the market manipulation. Of all the recommendations made by the committee, only one has been implemented so far, which is the reconstitution of the SEC. The new SEC is still to prove its effectiveness.

Despite so many unresolved issues, the market is trying to move forward. This has been demonstrated by the higher trade volumes in the last few weeks. The investing public simply cannot give up hope; after all, it was only last year that provided a 100% return. It is difficult to let go of the euphoria of a four-year bull market and a 250% return. However, the advances also proved very tentative; a major retracement followed every short rally. The latest rally was driven by a government decision; that of allowing undeclared wealth in the market. The investors seem to be willing for the market to take off, but there are few tricks left. Whether you like it or not, we seem to be in for a bear market. The following factors will put further downward pressure on the market.

Lack of liquidity
After running an inflationary monetary policy for several years, the central bank has opted for a contractionary one. While credit growth is desired, it will be allowed to happen only in productive sectors. It does not seem that credit expansion in the stock market is a high priority. Consequently, the capital market will be squeezed out of liquidity in a number of ways – through a control of margin lending, a higher capital requirement for margin lending and limit of lending against capital market assets. Increased bank-borrowing by the government, if it happens, will also reduce liquidity in the capital market.

Diminishing middle-class savings
Despite a perception that stock market investment is concentrated among a few large investors, small investors provide a major part of the invested capital. As climbing food and essential prices squeeze the savings of small investors, their contribution to the capital inflow has diminished. There is no sign in the economy that middle-class income would improve in the immediate future. Shutting off of the middle-class from the capital market would further reduce demand pressure.

Absence of foreign portfolio investment
Emerging market investors represent smart money; it follows opportunities anywhere in the world. When emerging markets are depressed because of domestic weakness, foreign portfolio investors take advantage of such buying opportunities. This outside investment helps to stabilize the market. Both Pakistan and Sri Lanka benefitted from such portfolio investment inflow. This is less likely to happen in Bangladesh. In the last few months, Bangladesh capital market has drawn attention for the wrong reasons, including an unusual rally followed by a precipitous drop, street demonstrations by irate investors and wrong policy responses. Thus far, the government has not done very much to establish that this is a normally functioning market. Even emerging or frontier market investors have a limit to their risk-taking.

Animal spirit fades away with time
Nothing succeeds like success - a bull market draws more new investors and creates its self-perpetuating momentum. The reverse is also true. A market that does not advance or loses momentum also loses the confidence of its investors. If our market fails to hold a healthy rally in the near future, it will start losing followers. No longer will it dominate the conversation at the tea-stalls or the water-coolers. Casual investors will just liquidate their positions and hang up their hat. One has only to remember the period between 1996 – 2004.

Political tensions
Better leave it to political commentators to foretell the political landscape in the next two years. Whatever way it turns, it would have a direct effect on the economy and the capital markets.

Where to invest
No doubt, the outlook is not too bright. However, those that do not regard the stock market as a casino and do not expect to double their money overnight can still take advantage of the unfolding scenario. All one has to do is heed to Rudyard Kipling, that “IF you can keep your head when all about you are losing theirs … yours is the Earth and everything that's in it”. In other words, when everyone panics, sells and leaves the market, that is the perfect time for the savvy investor to buy and build his portfolio. Some high-quality stocks are returning to earth from their stratospheric levels, especially the multi-national companies. Most of these companies operate in vital and essential economic sectors and should maintain their revenue and margins despite a slowing economy. They have some semblance of corporate governance, honest accounting and disclosure. Their dividend yield is already respectable (about 5%) and will improve if prices fall further. The banking sector is also an attractive investment option because of potential growth of banking services in Bangladesh. However, one has to be cautious in selecting banking names.

Preparing for the future
While the market falls, slows down and fades away from public discourse, the regulators should not go on hibernation. Some significant reforms were accomplished during the period 1996-2004 when market activity was limited. Those included activation of a central depository system, introduction of paperless trading and separation of investment banking from brokering. Latest market crisis proved that while those reforms were useful, those were not sufficient. A long list of changes and reforms needs to be carried out. I hope that once the SEC gets over its fire-fighting mode, it shall focus on the necessary reforms.

A make-believe crisis in the stock market

A number of newspapers recently reported that in the past few days, nationalised commercial banks and financial institutions have been actively buying in the stock market in order to 'bring normalcy' to the market. I guess the definition of normalcy is price appreciation every week in the magnitude of 2.0 to 3.0 per cent for an annual return of over 100 per cent. Otherwise, in a market that has a price to earning (PE) ratio of over 30, how does the fall of stock prices by a mere 15 per cent in total can be construed anything but normal? Even after recent corrections, the PE ratio is over 25. Putting in perspective, if investors depend only on earnings of the invested companies for return of their capital (let alone any return on capital), they would have to wait for long 25 years. No other comparable stock markets have a PE ratio over 20. In the past 10 years, even Bangladesh stock market traded at a long-term average PE of 20. If such is the case, why a market that is overvalued by at least 25 per cent needs state support? When correction in the market is overdue and is actually a healthy development, why the state is pouring good money into a flawed system, and to whose benefit?

What bothers me most is the mode of the intervention. The news reports state that the Investment Corporation of Bangladesh (ICB) received Tk 2.0 billion 'financial assistance' from the central bank to intervene in the market. ICB used this money, along with its own funds as well as funds from its mutual fund portfolios to purchase stocks whose prices were falling. I guess the same is true for other state-owned banks and financial institutions, as well as some private financial institutions. The whole process is wrong, offensive, foul and reckless in a number of ways. First, this is a clear transfer of state funds to speculators without any accountability. Bangladesh capital market is nowhere near to being an important contributor to national growth that it would have to be propped up by transferring public wealth to rowdy speculators. Second, there seems to be no accountability or policy direction by the government for ICB or others as to what securities should be purchased with this 'financial assistance'. It means these parastatals can use this fund to purchase any stock they wish to please any group of investors they want. Third, ICB is reported to have used cash from their mutual fund portfolios to purchase stocks whose prices were falling. The assets and the cash in the mutual fund portfolios do not belong to the ICB, to the Ministry of Finance or to the government. They belong to the mutual fund investors. What right does the ICB have to use their money and hurt their interests while implementing government policy decisions? This is a gross violation of investors' constitutional rights to own assets without government meddling. Finally, what is a normal state of the market where such intervention stops, at a PE ratio of 100? By a process called "reversion to mean," the market shall and must come down to a realistic level, no matter the size of the intervention. In this case, normalcy may mean a historical PE ratio of 20 or lower. By postponing the day of reckoning, what does the government achieve?

It is understandable that a political government would not want another stock market crash on its watch, and it would do everything to avoid such embarrassment. However, such embarrassment could be nipped in the bud many months ago. The whole affair started with banks' excessive venture in the stock market. As soon as the market PE surpassed the historical average, the central bank should have slowly limited banks' exposure. Instead, platitude substituted for sound policies.

When the horse left the barn, the central bank has been forced to take (or withdraw) measures, which are ignominious to the prestige of the institution. Instead of banks having to adjust by January 15 their loans diverted from industrial accounts to stock market, they now have unlimited time. A time-tested safeguard such as single borrower exposure limit has been relaxed. Finally, it is reported that the central bank has been asking banks not to sell their shares in a depressed market. Since when is it the job of the central bank to maintain the level of stock prices? Sooner or later the market would adjust downward and the banks would be left with losses from these investments. Is a weaker banking system more desirable than a weaker stock market? It appears that the discipline achieved through the Banking System Reform of the last decade could be lost while trying to defend a weak capital market.

The knee-jerk, reactive policymaking that is the hallmark of the Securities and Exchange Commission (SEC) seems to have spread upwind. I would also put the blame squarely on the media that unnecessarily magnified the stock market and its subsequent fall. Robert Shiller in his book "Irrational Exuberance" attributes excessive media coverage of the stock market as one of the causes for speculative bubbles. That surely was the case in our market. The recent market correction should have been ignored and viewed as what it was - a necessary lesson for foolhardy speculators. Instead, we are wasting valuable time, resources and political capital to remedy a make-believe crisis.

The Market Finally Crumbles

The rot started many months ago, the market finally crumbled Sunday. Between Sunday and Monday, the Bangladesh stock market lost more than 15%. For a small economy such as Bangladesh, a loss of wealth of almost US$ 7.5 billion, even on paper, is remarkable. Given the fact that many small investors flocked into the market lured by easy profit, the ripple effects would be wide-spread.

In 2010 alone, the market appeciated by 100%. In the three years (2007-2010), the average return was over 50%. The market appreciated so fast lately that the inactivity during the first part of the decade was overshadowed by the performance of the last three years, resulting in an average annual return of over 30% during this decade. Despite the current corrections, the magnitude of the return is still stupendous. In other words, nothing to feel sorry about the last two days' loss. After all in a market-based Lassiez Faire economy, nobody has the right to determine how others invest on their free own will.

However, last two years has brought in clueless investors in the market. These are investors with limited capital, limited knowledge and limited risk-taking capacity. Most diverted their funds from essential or productive activities. Most left their day jobs to ponder in the market. In other words, these people had no business partaking in this risky game. We shall keep hearing about the plight of the retired government officials, days together in the future.

In other places, this writer has tried to explain how the speculative bubble started in the first place. It was a confluence of factors, including lack of investment opportunities in the real sector, excessive supply of money and proliferation of trading facilities. Finally, banks' reckless participation in the market exacerbated the situation. What is pathetic is the role or lack thereof of the central bank. In keeping exchange rates fixed and favourable to exporters, it increased money supply without any care for inflation or asset price bubbles. What is more irresponsible is to let banks leave their traditional business and frolic freely in the stock market. Only in the last six months did the central bank notice that something was amiss. Only in the last three months did it actively enforce the rules limiting stock market participation by banks. The last central bank governor was too timid to enforce these rules against the veiled threat by the key functionaries or players in the market, the current one proved too populist to do the same timely. Would anyone care to comment why margin lending is regulated by the Securities and Exchange Commission (SEC) and not by the central bank?

We think the point is not missed by the current government that the stock market crash of 1996 was considered one of the failures of the then government, which precipitated its fall. We would expect them, rightly, to look for the sources of this crash. We would ask them to look at the right places, and not target phantoms such as "speculators" or "rumor mongers". Rather look for the SEC officials that changed rules (especially on margin rules) every few minutes either not knowing what to do or knowing too well how inside information works. Also, it is worth knowing what SEC officials, in connivance with the culprits of the last crash, were involved in overpricing initial public offerings (IPOs), especially mutual funds. Also why and who randomly changed rules regarding mutual funds trading to protect their own investments but misguided the rest of the market. It is easy to find out, with available trade records of the DSE, who bought in one name and sold in another name, thus manipulating the price of certain stocks. Look for names that were or are already discussed is the market, and determine what factors contributed their meteoric rise (5000%), despite those being crappy businesses.

In order to achieve double digit growth, we needed to raise our savings/investment rates by at least 10% of the gross domestic product (GDP), from 25% to 35%. Capital markets could be a very good source for that. It appears as in everything else, we killed the golden goose.

Capital market outlook

LOOKING over some numbers of the Bangladesh capital market, it would be an understatement to say that the price performance in the last few years has been remarkable. According to the numbers published by the Dhaka Stock Exchange (DSE), the market has generated annual price return of 30 per cent in the last 10 years. Putting that in perspective, it is about two and half times the return generated by banks' fixed deposits. The annual return in the last three years is 52 per cent (since 2007). Year to date (YTD) return in 2010 is 94 per cent, and there is still a month and half to go. We usually become doubly sad if an elderly relative dies at 99; it appears that the Dhaka market would not leave us in any such regrets. The annual return should comfortably exceed 100 per cent.

Some people are skeptical about the performance calculations made by the DSE, and rightly so. If correctly calculated, a market-cap weighted index for the last 10 years tells of a more astounding performance. Annualised returns have been 37 per cent in the last 10 years, 60 per cent in the last three years and 92 per cent in YTD 2010. It is not a coincidence that the performance measure for 2010 matched DSE's. Only this year did they figure out how to calculate correctly a market-weighted index. However, index values in previous years were not revised. So what the DSE puts forward as an index value is a meaningless number, calculated differently at different times. It implies as if the DSE portrays a bird that has the legs of a stork, the body of a hen and the wings of a turkey.

Nevertheless, whatever measure we use, the market performance has been significant. Although market participants would like to claim genius for such great a performance, there have been a few extraneous contributing factors. First, the economy is flush with excess cash. Money supply in the last five years has grown by an average of 20 per cent, whereas the nominal GDP has grown by 14 per cent. The difference has appeared in the economy as excess cash. In order to keep the exchange rate stable to facilitate export, Bangladesh Bank made a number of large foreign exchange purchases from the open market. In the last fiscal alone, the purchase was for an amount of over $2.0 billion. Secondly, because of lack of power, gas and other infrastructure, investment in the real sector has stalled. Usually the net savings of a country equals net investment. Because of structural inefficiencies in Bangladesh, there has always been a gap between savings rate and investment rate and this year it has gone up to 5 per cent. Both banks and businesses have invested their excess cash in the capital markets. Although this has improved their short-term profitability, their core business has shown little growth or improvement. An excess supply of cash combined with lack of real investment opportunity has caused to move enormous amounts of funds into the capital markets, moving the only 260 odd stocks in the market to stratospheric levels.

The secondary effect of this has only perpetuated the trend. Hugely lucrative return in the market has given rise to the number of capital market intermediaries and has drawn in new investors and additional funds. These new investors have bought at higher prices, pushing the market even higher. A measure of the proliferation is the number of Beneficiary Ownership (BO) accounts, which has grown from about 350,000 in 2005 to 3.5 million in 2010. That is a 10 times increase in five years, or a 60 per cent growth each year. Capital market has finally arrived at far flung district towns. The word in the market is that many new investors are small businesspeople, who have committed their business capital to trading shares. We cannot imagine the scary scenario whereby a major correction impacts the market; the impact on these small investors would be horrendous.

Is such a correction imminent? Are we looking at a hard or a soft landing? Two of the three trends that contributed to the capital market growth are abating. First, with increasing inflation, the Central bank has very little incentive to increase money supply. Second, appreciation of the Taka would not be such a bad thing on the balance, if a stronger Taka buys more food grain. This is especially true when purchasing grain from neighboring India whose currency has steadily appreciated against the US dollar. Third, with a downward trend in net migration, remittance flow may weaken and further remove the need for monetising foreign currency reserve. Fourth, bank deposit rates are improving, making them a more competitive (and safer) alternative to capital markets. Fifth, real investment is picking up despite the agonizing delay in gas and power supply.

All these developments point to a correction in the capital market. This potential is further augmented by the fact that the government seems determined to offload a huge quantity of public company shares. If the government really follows through on its promises, i.e. selling of further shares of listed companies and listing other public companies, the market would experience a large supply of new shares amid a declining money supply. This further supports the potential of a correction in the market. What the government failed to do by managing demands (margin loan reduction) could well be achieved by a supply side intervention. It seems likely that the market would return to normalcy by substitution of funds from old to new shares, not by a drastic fall of confidence or by panic withdrawal of funds by investors. Even if it is preceded by a price correction, that would be a healthy development for the market.

A saving grace for the market is the improvement in earning by well-managed companies. Among all stocks in the market, a select group of large, most liquid, well managed (using some subjective criteria) companies grew their earning by an average of 20 per cent in the last five years. If this trend continues for the entire market, the current P/E ratio of 27.0x should come down to 22.0x in 2011 and 18.0x in 2012. The effect is more dramatic for our select group of stocks; for them the P/E would come down to 15.0x in 2011, provided that the current price levels do not change further. However, to take comfort in such a scenario, we have to be confident about the quality of reported earnings.

If there is a major correction despite such positive developments, what are the consequences? The fickle nature of public sentiment does not always follow logic. No one knows when fear takes over greed, and when it does, the platitudes by the powerful do not mean much. In course of a major correction, would the government intervene for the sake of public sentiments, or would it let the market decide? Would the banks, especially the state-owned banks, be forced to purchase stocks, or would they be allowed to reduce exposure to minimise losses? If banks are indeed forced to make large purchases in the stock market when prices are falling, what does it do to the soundness of the banking system? Would the margin ratio be suddenly made wide open as a means to supply liquidity? We ask what lessons have been learned since 1996 to develop a playbook for a share market crisis.

Rather than an amazing price performance, a much more important need is a fluidity of the market where entrepreneurs can easily raise funds for productive business enterprises.

As we increasingly look at the capital market for financing projects of national importance, it is important that the depth and the breadth of the market improve and confidence in the market is maintained. It is our expectation that we shall make progress toward that goal in 2011. Such a market needs policy stability, not reactive decisions every few days. Ensuring that genuine entrepreneurs look at the market as a source of capital is more important than ensuring the moral hazard of incidental investors who foolhardily buy at high prices.

Of Mutual Funds Activism

THE mutual funds industry in Bangladesh is at its infancy. If the mutual fund complex is allowed to develop efficiently and naturally, it improves national rate of savings, helps to mobilize investable funds, acts as an efficient conduit to raise capital and functions as a social safety net. Given the importance of an efficient mutual funds industry, it is important for early participants to remain extra fair and cautious. This is especially true in our country, where misperceptions rule in the mutual funds market. Some outcomes of misperception are overvaluation, excessive trading and perceived irregularities related to pre-IPO placement. A fair amount of activism is necessary by early participants to educate the market. The most pressing objective should be achieving transparency and discipline in the investment process of mutual funds.

While the activism is there, the mission seems to be misdirected. The Financial Express of July 25 reported that representatives of three Asset Management Companies (AMC) out of nine licensed AMCs recently met with the Chairman of the Securities and Exchange Commission (SEC). In that meeting they offered recommendations about the mutual funds industry, which included lifting of margin restrictions, relaxation of limits on pre-IPO placement and reduction of the lock-in period for pre-IPO placements. These recommendations hardly address the real problem of the industry, which is lack of transparency. Liberal use of margins would leverage fund units, which are comprised of stocks that are already overvalued because of over-leverage. Relaxation of placement cap and reduction in lock in period would encourage the business of pre-IPO placement, which seems to have become the main business of some AMCs. This would also encourage excessive trading, which beats the purpose of holding mutual funds. If implemented, these measures would surely benefit asset managers, brokers and beneficiaries of pre-IPO placements. No wonder that some asset managers are resorting to trade-union like behavior in lobbying the regulator. However, if implemented, these measures would continue to perpetuate the problems in the industry. The suggestion that a real fund manager can add value to his portfolio by any means other than stock selection seem appalling to genuine fund managers. Life support such as margin loans or shorter lock-in can prop up the portfolio value for a short-time, but the day of reckoning eventually arrives. Most times it affects small investors who are left with empty bags.

To ensure a steady growth of the industry, we must also ensure transparency in the industry. The first step would be to adopt a universal fund accounting policy. That would ensure that funds own the securities they claim to own, and trade allocation among various accounts is done fairly. Second, funds must announce their holding and their trades at the end of each quarter, along with their net asset value. Third and most important, there has to be an adequate supply of new securities in the market for mutual funds to choose from. Otherwise, funds and retail investors alike would continue chasing the same stocks, ultimately creating unsustainable and bubble-like price levels.

In response to an op-ed published on the Daily Star recommending companies investing their capital into the share market.


Counterpoint – Investing in share market as a corporate financial strategy
I refer to the article titled “Investing in share market as a corporate financial strategy” published on the Point Counterpoint section of the Daily Star of December 18, 2009 (http://www.thedailystar.net/newDesign/news-details.php?nid=118115). The writer recommends that businesses invest their capital in the securities market as part of their investment strategy. I could really do with clarification on certain points. First, is the writer suggesting this strategy for companies or individually/family owned businesses? If it is the latter, then it does not matter if the owner deploys funds in the capital markets in his own name or in the name of the business. Second, if this is suggested for companies, is this a strategy for management of temporary excess cash? Global corporations resort to the capital markets often for such a purpose, but there are special vehicles for this purpose such as commercial papers. In the absence of such vehicles, it is just more convenient to use the treasury management services of banks. Third, if this is more of a permanent investment strategy, what is the optimum level of capital that may be taken away from the core business of the company to invest in the capital markets? If shareholders of such a company desired to invest in the capital market, would not they already have done so instead of forming the company? I am not too sure if the writer is suggesting investment in the capital market as a remedy for everyday business challenges such as “collection hassles”. If the rate of return from such a business, despite the various hassles, is more than other alternatives, then diverting capital from the core business of a company to invest in the capital market appears to be a blatant violation of corporate governance. If the company is not profitable in its core business or if prospect for its growth is bleak, then the company should return all its capital to the shareholders by a special dividend and cease existing. There is no reason to foray into the capital markets other than for management of short-term excess cash.
The writer suggests that a corporation’s investment in the capital market creates jobs, increases financial activities in the system and thus contributes directly to the economy. That begs the question; does a corporation not achieve the same results even more efficiently by focusing on its core businesses, such as manufacturing, food-processing, running logistics, importing-exporting goods, or providing essential services? If all that our corporations do is to engage in the capital market, then who is going to conduct such essential businesses? Also, what would these companies invest in; other companies that in turn invest in them? That would create an economy whereby no one produces anything but only trades each other’s shares in the proverbial “nation of traders and shopkeepers”. This also seems a recipe for asset-price inflation, which always ends in a burst of the bubble. The ideas stated in that article are half-baked at the best and misleading at the worst. The writer, who appears to be a senior executive at a capital market institution, should have known better.

Outlook for the Banking Sector in 2010

A less than exciting year 2009 for the banking sector
Despite a late-year rally, Bangladeshi commercial banks had a lackluster performance in 2009. Although most banks improved their profit figures, the spectacular growth in yester years stalled during 2009. In the backdrop of over 30% loan and deposit growth even by the average bank in previous years, loan growth for the industry slowed down to about 15% in 2009. Despite a more favorable political climate, investment did not pick up during the year.

Overhang of the commodity price adjustment…
During the first half of the year, large trading houses (that are also the largest corporate clients of banks), were stuck with large positions in commodities acquired at high prices during 2008. As commodity prices retreated, both these corporate clients and their banks were cautious in making large investments in commodities. As a result, commodities and raw materials import decreased by as much as 20% compared to last year.

Global recession and crisis of confidence …
Although publicly adorning a brave face, no one in the business community really believes that Bangladesh will remain unscathed during the global recession. Because of low connectivity with global economy and catering to the lower-end of the western consumer market, the effect has been delayed and subdued so far. However, not knowing the extent and the duration of the recession, businesses are not very excited about making new investments, especially in textiles and readymade garments (RMG) that are the main drivers of export. Although domestic demand has improved, the questionable outlook for remittance, agriculture and export earning did not provide enough incentive to invest.

Lingering infrastructure problems…
The country currently faces a 25% shortfall in electricity generation (5,000MW of demand as opposed to 3,800 MW of supply) simply to supply current connections. As much as 50% of the country still does not have access to electricity. Due to lack of new supply of natural gas, new gas connection has been withheld for almost six months. Although road and port services have improved, they are still inadequate to open up new industrial zones. No entrepreneur would be excited about the prospect of less than 50% capacity utilization because of lack of such essential services.

Heaps of excess liquidity…
As of September 2009, the banking system had idle liquidity of BDT 340 billion. This was an improvement over liquidity in June 2009, which was BDT 350 billion. In one year since June 2008 when excess cash in the system was BDT 130 billion, liquidity went up by 170%. This resulted from a confluence of factors including lack in investment and monetization of incoming forex. As a result of excess liquidity, inflation rate after an initial cooling down is on the rise again. Another concern is the expansion of credit in absence of industrial, commercial and agricultural lending; in such a scenario credit may find way into excessive consumption or the capital markets, which may create bubbles. Banks removed some liquidity from the market, but instead of going into lending, some of it found way into government securities. Although banks tried to reduce the speed in deposit taking, this idle liquidity still put pressure in their interest burden. The squeeze in profitability may be further felt in 2010 if investment does not accelerate.

Priming the pumps…
A number of large business houses were affected by the crackdown on corruption during 2007-2008. The necessary adjustment for them with a new political environment may have lingered the slow investment climate. The construction sector was especially affected as investment of undeclared funds in real estate was closely scrutinized. Besides, government development projects through the annual development programs (ADP) remained slow and achieved an implementation rate of only 60%.
Model of large corporate-based lending is challenged…
In excess of 30 banks are vying for the business of the same handful of corporate clients. Growth in earning of most banks suffered as large corporate clients stopped borrowing. This accentuates the lack of loan and income diversification by most banks. It is not surprising that more and more banks are vying for the missing middle (the SME sector) where some banks have commanding lead.

Capital markets, the savior…
A saving grace for the banks was the strong rally in the capital markets. Banks with large exposure in the capital markets gained windfall profits in three ways; through appreciation of their proprietary portfolios, by collecting trading commission from an increasingly active market, and by lending in margin to retail investors with unbelievable spreads (thanks to plummeting money market rates). In a banking industry with limited service offering, fees and commissions for some banks exceeded 30% of their operating profit. A growth in the breadth and depth of the capital market would most definitely favor the first-mover banks, but current growth in commission income may have gotten ahead of itself in a shallow market. Another issue of importance is the directive by the central bank to create separate subsidiaries for merchant banking and brokerage businesses. Banks may be constrained in margin lending because of a limit on the capitalization of subsidiaries. This may subsequently reduce the interest income from securities business.

Outlook for 2010: more permissive regulatory environment
Some of the structural problems would remain for the banking sector in 2010. Infrastructure problems do not go away overnight and global recession may eventually take its toll on remittances and RMG export. Despite the hitherto resilience of the domestic sector, the outlook for agriculture (the largest driver of the domestic economy) remains less than certain this year. On top of the macroeconomic variables, the banking sector will deal with a number of regulatory and structural issues.

A liberal monetary policy…
Bangladesh Bank (BB) implied that it would continue the current liberal monetary policy to promote what the new Governor has termed an “Inclusive Growth”. In balancing between growth imperative and inflation fears, the bank seems ready to side with growth. BB has targeted over 16.7% growth in private credit-flow in 2010. BB has either eased or has hinted at easing its monetary instrument tools and such as repurchase (Repo) and outright transactions in government securities (Open Market Operations).

Exchange rate intervention…
Foreign exchange reserve continues to improve, mainly supported by strong remittance flow. Current reserve at over USD 10.5 billion is highest in the history. The high foreign exchange reserve also illustrates the lack of economic activity, especially the significant reduction in raw materials and machinery imports. As excess supply of forex forces appreciation of the BDT and poses a threat to the export sector, BB made several soft interventions in the market by purchasing USD from banks. In the past two years, BDT has traded within a very narrow band, partially because of interventions by the BB. Despite increasing remittance in the latest months, BB has managed to monetize the forex without significant increase in inflation. Picking up of investment and reduction in remittance (both of which look realistic) may ease need for interventions before any significant effect in inflation.

Managing lending and borrowing rates…
BB has held the view that interest rate spread in the country is excessive and should be brought down below 5% in order to increase credit flow. Spread in Bangladesh averages 5.0% - 5.5% whereas in neighboring India the range is 4.5% - 5.0%, a full 100 bps less. Instead of moral-suasion that has been the practice of the central bank, it directed all banks in April 2009 to put a ceiling of 13% on lending rates (except for consumer loan, small enterprises and some trade financing). Consequently, Bank associations as a group have decided to lower deposit rates, trying to effectively maintain the spreads. There are a few consequences of this dance; first to maintain profitability, banks may favor higher rate higher risk consumer loans; second, investors chasing yield enter the stock market and drive up price-levels. Neither of these are desirable outcome. Weaker banks may break rank with the associations by offering higher deposit rates in order to compete for deposits.

Central-bank’s vision of “Inclusive Growth”…
The current central bank governor has set out a vision for the central bank that is true to his development finance background. In his view, a "broad-based, inclusive, socially and environmentally responsible economic growth is viewed by Bangladesh Bank as the way forward in strengthening domestic demand and intra-regional trade." He set out a target of 25% of lending portfolio of banks to be directed to agro-related businesses. There are other directives encouraging lending to SME, women-entrepreneurs and socially-responsible businesses. While none of this conflicts with the principal objectives of banks, which is lending to profitable businesses, banks may be challenged to meet all of these directives and still maintain profitability in a slow-investment environment.

Rescheduling may hide the true story of NPLs…
BB has given a wide discretion to banks allowing rescheduling of defaulted loans to export-oriented sectors within June 2010 without any down-payment. An even more curious step was to allow rescheduling of defaulted loans by businesses of 30+ people who have been “unduly harassed” by the past caretaker government. As defaulters start taking advantage of these benefits, NPL percentage of banks may decline without any real change in the asset quality. Earning quality may also be distorted as provisioning is reduced. In the first half of 2009, NPL growth of foreign banks exceeded the sectoral average, which was surprising given the more stringent lending criteria of such banks. Regularizing of defaulted loans by rescheduling may hide the true picture of bank-asset quality.

Discipline in the banking sector…
Over the years, the central bank has done a good job of bank supervision. Its success is evident in the lowering of NPL for the entire banking sector including the state-owned banks (came down from over 40% in the 1980s to less than 11% currently), ensuring better corporate governance by imposing strict guidelines for the appointment of management and boards, taking decisive steps in handling troubled banks, improving the Credit Information Bureau (CIB), and lastly using a carrot and stick policy for chronic loan-defaulters. Some recent policy decisions by the Ministry of Finance and BB appear to be at odds with the previous track-record. We hope that such relaxation is part of the government’s stimulus plan and a selective relief does not escalate moral hazard.

Long-term outlook for investment in bank stocks
Despite current challenges, the banking sector remains one of the most attractive investment choices in the Bangladesh capital market. It already constitutes about 30%of the total market capitalization of the DSE. The banking sector experienced a late year rally in 2009. However, the banking sector is still in its initial stage of growth in Bangladesh, and opportunities exist for selective investment in the banking sector.

Banks give an exposure to the entire economy…
While there is a debate on a realistic date for Bangladesh’s elevation to the mid-income country group, there is no doubt about the prospect for above-average growth rate. The financial system in this country is still bank-based, and banks would finance most development activities in the near-future. In the absence of a broad-based capital market, banks provide best exposure to the country’s economic growth.

A large unbanked population will drive further growth…
Banks have achieved more than 30% asset growth on average in the last five years, compared to less than 20% growth in India and China, two Asian giants. Still, only 25% of the country’s population has access to banking services. According to a report published by the World Bank on “Access to Finance”, only 23% of the bankable population has a deposit account whereas only about 6% of the people have a loan account. In comparison, the numbers are 94% and 23% respectively in neighboring Sri Lanka (India falls in between). The global benchmarks for these numbers are 150% and 50%, respectively. Bangladesh Bank is preparing a strategic plan that targets inclusion of a broader population in the banking network, which would help expanding banks’ revenue-base.

Limited product range leaves room for diversification…
Until recently banks focused largely on conventional lending. In an environment of big interest rate spread, they did not have an incentive for product diversification. As businesses and consumers become more mature, innovative banks will bring new products to the market to meet their demand. This creates an opportunity for differentiation. Although a number of banks have nibbled in the capital markets, they have only scratched the surface. As income level improves and wealth is created, there would be huge need for wealth management and other fee-based services. On the supply side, as businesses look for innovative financing, an opportunity awaits banks in merchant banking. Banks need to take a long-term view and make the effort to develop skilled staff.

Investor-base and liquidity…
Because of dilution over the last two decades, banks have a large and diversified investor base. Consequently, the banking sector offers the most fundamentally-driven investment vehicle, where price manipulation is minimal. There is ample liquidity in the market for most banks. It is also the best regulated sector under the supervision of a fairly competent central bank. Improvement in disclosures and financial statements attests to improving governance. Few other industry sectors in the Bangladesh capital market have these characteristics.

A more competitive environment…
An environment of windfall profit for banks comes to an end as investment slows down, rates reduce, competition for deposits intensifies and other savings instruments emerge that compete with plain vanilla fixed deposits. In a more competitive environment, only better-capitalized and better managed banks offer good return prospects. Management quality, vision, investment in technology, focus on operating efficiency, and ability to develop niche markets will separate the men from the boys in the future.

মিউচুয়াল ফান্ড ইউনিটের মূল্য: কিছু প্রাসঙ্গিক প্রশ্ন

বিগত কয়েক মাসে বাংলাদেশের পুঁজিবাজারে বেশ তেজিভাব লক্ষ করা গেছে। গত ২৫ অক্টোবর ঢাকা স্টক এক্সচেঞ্জের সাধারণ মূল্যসূচক (ডিজিইএন) সর্বকালের সর্বোচ্চ সীমা অতিক্রম করে। ২৬ তারিখে সাধারণ মূল্যসূচক ছিল ৩৩১১ পয়েন্ট, যা জুলাই মাসের শুরুর মূল্যসূচক থেকে প্রায় ১৭ শতাংশ বেশি। মাত্র তিন মাসের ব্যবধানে পুঁজিবাজার থেকে এই পরিমাণ মুনাফা সামান্য ব্যাপার নয়। আমাদের পুঁজিবাজারে গত বছরের আয়ের তুলনায় এখনকার মূল্য প্রায় ২০ গুণ, অর্থাত্ পুঁজিবাজারের এখনকার মূল্য আয় (পিই) অনুপাত ২০×। পিই অনুপাত পুঁজিবাজারের মূল্যমানের একটি বহুল প্রচলিত নির্দেশক। পিই অনুপাত সাধারণভাবে বোঝায়, কত বছরের আয় একসঙ্গে যোগ করলে একটি শেয়ারে আপনার বিনিয়োগ সম্পূর্ণভাবে ফেরত পাবেন। পুঁজিবাজারের সঙ্গে তুলনা করুন অন্য যেকোনো বিনিয়োগের, যেমন—পোলট্রি ফার্ম। বিনিয়োগ ফেরত পেতে আপনি কি ততদিন অপেক্ষা করতে রাজি?
আজকের তুলনায় ২০০৯ সালের শুরুতে পুঁজিবাজারের পিই অনুপাত ছিল ১৮.৪×, ২০০৭ সালের শুরুতে ছিল ১৪.৫×। শেয়ারের দাম বা মূল্যসূচকের এ ধরনের ঊর্ধ্বগতি সত্ত্বেও কারও পক্ষে নিশ্চিতভাবে বলা সম্ভব নয় যে, বাংলাদেশের পুঁজিবাজার অতি মূল্যায়িত বা শেয়ারের দাম অতিরিক্ত বেশি। পুঁজিবাজারে মূল্যমানের অনেকগুলো নির্ধারক আছে, যেমন: আগামী বছর লাভের সম্ভাবনা, জিডিপি প্রবৃদ্ধি, সুদের হার, মূল্যস্ফীতির হার, বাজারে অর্থের জোগান (সরবরাহ), পুঁজিবাজার ছাড়া অন্যান্য বিনিয়োগে মুনাফার হার ইত্যাদি। এই নিয়ামকগুলো একে অপরের সঙ্গে সম্পর্কিত হওয়ার কারণে শেয়ারের মূল্যমান সম্পর্কে আগাম ধারণা করা বা সুনির্দিষ্ট মত দেওয়া কঠিন।
তার পরও বাংলাদেশের পুঁজিবাজারে এক ধরনের শেয়ার সম্পর্কে সুনির্দিষ্টভাবে বলা যায়, এগুলো অতি উচ্চমূল্যে লেনদেন হচ্ছে। বর্তমানে মিউচুয়াল ফান্ড ইউনিটগুলো যে দামে বিক্রি হয়, তা কোনো যুক্তিতেই স্বাভাবিক নয়। পুঁজিবাজারে ১৭টি মিউচুয়াল ফান্ডের ইউনিট গড়ে তাদের নিট সম্পদমূল্যের ২ দশমিক ৮ গুণ এবং গত বছরের আয়ের ৭৫ গুণ বেশি দামে লেনদেন হচ্ছে। এর সঙ্গে আমরা তুলনা করেছি এশিয়ার বিভিন্ন দেশের ২১টি মিউচুয়াল ফান্ডের দাম। এই ২১টি ফান্ড তাদের নিট সম্পদমূল্যের শূন্য দশমিক ৯১ গুণ দামে বা নিট সম্পদমূল্যের কমে লেনদেন হচ্ছে। বাস্তবে নিট সম্পদমূল্যের থেকে বেশি দামে মিউচুয়াল ফান্ড লেনদেন হওয়ার কোনো কারণ নেই।
কোনো নির্দিষ্ট দিনে মিউচুয়াল ফান্ডের নিট সম্পদমূল্য নির্ধারিত হয় এভাবে: মিউচুয়াল ফান্ডের অধিকৃত শেয়ার বা অন্য সম্পদের মোট মূল্য থেকে মোট দায় বিয়োগ করে পাওয়া যায় নিট সম্পদ। এই সংখ্যাকে মিউচুয়াল ফান্ডের মোট ইউনিটসংখ্যা দিয়ে ভাগ করলে ফান্ডের ইউনিটপ্রতি নিট সম্পদমূল্য পাওয়া যায়। মিউচুয়াল ফান্ডের একটি ইউনিট বলতে তাই বোঝায় এক ঝুড়ি শেয়ারের আংশিক মালিকানা।
বোঝার সুবিধার জন্য একে তুলনা করা যায় এক ঝুড়ি ফলের সঙ্গে, যেখানে আছে এক ডজন কলা, ছয়টি আপেল ও ছয়টি কমলা। ধরুন, খোলাবাজারে কলা, আপেল ও কমলার ডজনের দাম যথাক্রমে ৯০, ১৭০ ও ১৭০ টাকা। ঝুড়িটির দাম যদি হয় ২০ টাকা, তাহলে সেই এক ঝুড়ি ফলের মোট মূল্য হওয়া উচিত ২৮০ টাকা। যদি এই ঝুড়ি বাজারে বিক্রি হয়, তাহলে আপনি কি তা ৩০০, ৪০০ বা ৫০০ টাকা দিয়ে কিনবেন? পুঁজিবাজারের মূল্যমান অনুযায়ী প্রতিটি ঝুড়ি এখন লেনদেন হয় গড়ে ৭৮৪ টাকা বা নিট সম্পদমূল্যের ২ দশমিক ৮ গুণ বেশি দামে। যদি খোলাবাজার থেকে ফল কিনে ঝুড়িটি আপনি নিজে তৈরি করে নিতে পারেন, তবে এই অতিরিক্ত মূল্য দেওয়ার কোনো কারণ আছে কি? মিউচুয়াল ফান্ডের বেলায় একই কথা খাটে। কারও কারও মতে, ফান্ডের ম্যানেজার বা তহবিল ব্যবস্থাপক তাঁর ভালো শেয়ার চেনার দক্ষতা দিয়ে ফান্ডের ভবিষ্যত্ সাফল্য নিশ্চিত করেন, তাই এই উচ্চমূল্য। বাস্তবে ফান্ডের অধিকৃত যেসব মানসম্পন্ন শেয়ারের ওপর ফান্ডের ভবিষ্যত্ সাফল্য নির্ভর করে, তাদের স্বতন্ত্র মূল্যেই এই ভবিষ্যত্ সাফল্য প্রতিফলিত হয়। যেহেতু ফান্ডের নিট সম্পদমূল্য একক শেয়ারগুলোর মূল্যের যোগফল, তাই দ্বিতীয়বার ফান্ডের মূল্য বাড়ার কোনো সুযোগ নেই।
ফান্ডের মূল্য যে নিট সম্পদমূল্যের চেয়ে বেশি হওয়ার কোনো কারণ নেই, এটি অন্যান্য দেশের পুঁজিবাজারে সবাই বোঝে। কেবল ‘বাংলাদেশের পুঁজিবাজার ভিন্ন প্রকৃতির’ এই অমোঘ সত্যটি বোঝানোর জন্য আরও দুটি যুক্তির আমদানি করা হয়। প্রথমটি হলো মিউচুয়াল ফান্ড সম্পর্কিত উচ্চ আদালতের মামলা। এখন আদালতের রায় যেদিকেই যাক না কেন, তা মিউচুয়াল ফান্ডের দামকে প্রভাবিত করার কোনো কারণ নেই। লভ্যাংশ দেওয়া হলে তা দেওয়া হবে ফান্ডের মোট সম্পদ থেকে, অর্থাত্ লভ্যাংশ দেওয়ার পর ফান্ডের সম্পদমূল্য এবং বাজারমূল্য ঠিক সেই পরিমাণেই কমে যাবে। এ ছাড়া আমাদের পুঁজিবাজারে যে বোনাস শেয়ার দেওয়া হয়, সেটাও মূলত অর্থহীন। বোনাস শেয়ার হচ্ছে কোম্পানির পুঁজির (ক্যাপিটাল) পুনর্বিন্যাস, যে পুঁজির মালিক এমনিতেই শেয়ারের ক্রেতারা। বোনাস শেয়ার দেওয়ার মাধ্যমে ব্যবসার লাভ যেমন বাড়ে না, তেমনি শেয়ারের ক্রেতাদেরও কোনো বিশেষ সুবিধা দেওয়া হয় না।
ফান্ড ইউনিটের উচ্চমূল্যের আরও একটি কারণ হিসেবে উল্লেখ করা হয় আইপিওতে মিউচুয়াল ফান্ডের জন্য সংরক্ষিত শেয়ারের বিষয়টিকে। আমাদের সিকিউরিটিজ আইন অনুযায়ী যেকোনো আইপিওর ১০ শতাংশ শেয়ার মিউচুয়াল ফান্ডের জন্য সংরক্ষিত। এটি নিশ্চিয় ফান্ড ইউনিটের দামকে প্রভাবিত করে, কিন্তু কতখানি? গত বছর পুঁজিবাজারে ১৬টি আইপিওর মোট মূল্য ছিল ৪১০ কোটি টাকা। আমরা যদি ধরে নিই, এর ১০ শতাংশ সে সময়কার ১৪টি মিউচুয়াল ফান্ডকে বিতরণ করা হয় এবং এই শেয়ারগুলোর মূল্য আইপিওতে ইস্যুকৃত মূল্য থেকে গড়ে ২০০ শতাংশ বৃদ্ধি পায়, তাহলেও আইপিওর শেয়ার থেকে মিউচুয়াল ফান্ডগুলোর লাভ হবে পাঁচ শতাংশেরও কম এবং তা কোনো অবস্থায়ই ১৮০ শতাংশ উচ্চমূল্যকে সমর্থন করে না। অধিকন্তু, বাজারে মিউচুয়াল ফান্ডের ক্রমবর্ধমান সরবরাহ ভবিষ্যতে আইপিও থেকে প্রাপ্ত লাভকে কমিয়ে আনবে।
মিউচুয়াল ফান্ডগুলোর লাগামহীন মূল্যবৃদ্ধি এমন পর্যায়ে পৌঁছেছে যে, বাজারে নতুন মিউচুয়াল ফান্ড চালু করার মতো সহজ ও স্বাভাবিক প্রক্রিয়াটি একটি নাটকীয় মাত্রা পেয়েছে। মিউচুয়াল ফান্ডটি কোন শেয়ার বা সম্পদে বিনিয়োগ করছে, তার চেয়ে বেশি জরুরি তথ্য হয়ে দাঁড়িয়েছে কারা এর বরাদ্দ পাচ্ছেন। অতি সৌভাগ্যবানেরা বরাদ্দ পাওয়ার পরপরই এই ফান্ড ইউনিট বিক্রি করছেন প্রায় আকাশছোঁয়া ২০০ শতাংশ লাভে। কিন্তু এটাও সত্য, আইপিও-পরবর্তী বাজারে (সেকেন্ডারি মার্কেট) প্রকৃত মূল্যের এত ওপরে বিনিয়োগ করা অত্যন্ত ঝুঁকিপূর্ণ। সময়ের সঙ্গে সঙ্গে যখন মিউচুয়াল ফান্ডের দাম তাদের সম্পদমূল্যের সঙ্গে সংগতিপূর্ণ হয়ে আসবে, তখন বেশি দামে কেনা অনেক বিনিয়োগকারী ক্ষতিগ্রস্ত হবেন। সাধারণভাবে বিনিয়োগকারীরা মনে করতে শুরু করবেন, মিউচুয়াল ফান্ডে বিনিয়োগ করাটা লাভজনক নয়। তাতে করে দেশি পুঁজি জোগানের এই সম্ভাবনাময় বাহনটির হয়তো অকালমৃত্যু ঘটবে।
এ ক্ষেত্রে সরকার বা পুঁজিবাজারের নিয়ন্ত্রক সংস্থাগুলোর খুব বেশি কিছু করণীয় নেই। বিনিয়োগকারী স্বেচ্ছায় কত দামে শেয়ার বা অন্য কোন সিকিউরিটি কেনেন, তা সরকার নির্ধারণ বা নিয়ন্ত্রণ করে না এবং মুক্তবাজার অর্থনীতিতে তা কাঙ্ক্ষিতও নয়। এ ক্ষেত্রে একমাত্র রক্ষাকবচ হচ্ছে ‘ক্রেতা সাবধান’ এই সতর্কতা। বিনিয়োগকারীদের সচেতনতা বৃদ্ধির মাধ্যমেই বাজারে এ ধরনের ঝুঁকিপূর্ণ প্রবৃত্তি এড়ানো সম্ভব।
এমন নয় যে, আমাদের দেশের বিনিয়োগকারীরা কাণ্ডজ্ঞানের ধার ধারেন না, তাঁরা কেউই ২৮০ টাকার ফলের ঝুড়ি ৭৮০ টাকায় কিনবেন না অথবা এমন কোনো ব্যবসায় বিনিয়োগ করবেন না, যেখানে বিনিয়োগের টাকা ফেরত পেতে ৭৫ বছর অপেক্ষা করতে হয়। অবস্থা দেখে মনে হয়, কেবল পুঁজিবাজারে এলেই বিনিয়োগকারীদের কাণ্ডজ্ঞান লোপ পায়। লোকে অতিমূল্যায়িত শেয়ার কেনে এই ভেবে যে, তার থেকে বড় বোকা তাঁর কাছ থেকে আরও বেশি দামে সেই শেয়ারটি কিনে নেবেন। কিন্তু মুক্ত ও স্বচ্ছ বাজারে কেউই যখন জানে না ঠিক কখন বিক্রি করাটা সবচেয়ে লাভজনক, তখন সম্ভাবনা থাকে, যে কেউই খালি ছালাটি হাতে নিয়ে দাঁড়িয়ে থাকবেন এবং সবচেয়ে বড় বোকা বলে প্রমাণিত হবেন। তাই শেয়ার কেনার সময় একমাত্র বিবেচনা হওয়া উচিত ব্যবসার ধরন ও ভবিষ্যতের আয়ের সম্ভাবনা। মিউচুয়াল ফান্ডের বেলায়ও এ ধরনের বিবেচনার ব্যতিক্রম হওয়া উচিত নয়।

Commercial banks' participation in investment banking

Until recently commercial banks have been involved in the capital markets mainly through ownership of brokerage businesses. Seventeen banks operate brokerage businesses as members of the Dhaka Stock Exchange (DSE). Historically revenue from securities business was low compared to a bank's core business of deposit-taking and term-lending. With a rising share market, contribution to revenue from the brokerage businesses has risen significantly. This has provided a much needed respite to many banks in the midst of reduced lending and trading activities. Most banks generated this extra revenue by lending to Beneficial Ownership (BO) accounts of investors against their stock portfolios at high interest rates (margin loans).

Because of a perception of easy profits, commercial banks are preparing to enter into the securities market on a larger scale. Many banks have either received or applied for merchant banking licenses, which would allow them to manage issues, underwrite public offerings, and offer wealth management services. Currently, banks hold 10, out of a total 31 merchant banking licenses. While diversification of revenue is desirable for banks, it is also important to note that the business of securities is different from that of banking, and presents different risks. The foray of commercial banks into the securities market raises some concerns, both from risk management and competitiveness perspectives.

Risk perspective: As new issues are few and far between, margin lending and trading remain the focus for merchant banking operations. Merchant banks are allowed to provide as much as 150% of the portfolio value in margin loans. Margin lending increased significantly in the last year. According to a report published in an English daily in its issue on July 14, 2009, two commercial banks increased their brokerage profit during first half of 2009 by 20% and 300% respectively, compared to last year.

Supposing margin interest rate and borrowing costs remained fairly same, it could be assumed that most commercial banks increased their margin-lending volume in similar degrees. During that period, market capitalisation of the Dhaka Stock Exchange (DSE) increased 21%, from Tk. 776.4 billion in June, 2008 to Tk. 938.0 billion in July 2009. New issues (a total of 16) accounted for only Tk. 4.1 billion of this increase. It can be safely assumed that margin lending played a role in this significant advance; excess liquidity drove up the share prices in a market that experienced limited security supply.

Margin lending is attractive to banks for two reasons; first, it earns interest income and second, it generates trading revenue. This is also true for independent merchant banks not affiliated with a commercial bank. However, banks can bring to bear enormous amounts of funds from their deposit base at a low cost. Consequently, they also have the ability to render a much larger impact on the market. In contrast, independent merchant banks have higher costs of capital and hence are more selective in margin lending. In a rising market, margin lending encourages speculative trading and creates significant risk for investors, for banks and for the market.

Risk to investors: A portfolio created out of borrowed funds magnifies the risk of losses. A 10% market correction causes as much as 25% loss to an investor who is leveraged 150%. An investor not only absorbs losses incurred on his own money, but also on the money borrowed, as the lender does not assume any market risk. If significantly leveraged, an investor may lose a large part of his savings during a big market correction.

Risk to banks: Although margin loans are secured by shares purchased, banks take on significant risk through such lending. A 40% correction in the market would wipe off the entire equity of the investor and expose the margin lender to losses. This risk is reflected in the new banking supervision rules; under Basel II framework, investment in equity should be risk weighted at 100%. In other words, no matter the quality of share, the margin loan disbursed against such security would have to be fully risk-weighted.

Risk to the market: Margin lending exacerbates market volatility. A rising market lowers margin ratio allows further borrowing and encourages more buying. This in turn drives up the share prices. In a falling market, brokers call for more collateral to cover margin, often forces investors to sell, which pushes prices down, and creates further selling pressure. Such increase in volatility is detrimental to market stability.

Competition perspective: Merchant or investment banks serve an important role in a capitalist economy. It ensures efficient capital allocation to profitable businesses, improves market liquidity, facilitates price discovery through vigorous trading and reduces cost of capital by innovative structuring. In such a skill-driven business, intellectual capital is much more important than financial capital. Such intellectual capital is developed through incessant focus on the market by capital market professionals. The same quality may not develop in a large organisation engaged in a multitude of businesses.

Banks are important players in capital market, but their unrestrained expansion would deter the growth of independent merchant banks. If size and easy access to capital become the only criteria in awarding merchant banking mandates, we will never see a rise of independent merchant banks that lead their respective markets in innovation and service quality.

Case for limiting bank participation in the capital markets: Regulators in many countries favour separation of banking and securities businesses. An early example of this approach is the Glass Steagall Act of the US Congress of 1933. This Act separated investment and commercial banking activities, preventing overzealous commercial bank involvement in stock market. It was deemed that such involvement caused the banking crisis of 1929 when commercial banks took on too much risk with depositors' money. The core banking practices of deposit taking, term lending and risk management took a backseat. In many cases, banks would issue unsound loans to companies in which it had invested. Clients would also be encouraged to invest in those same stocks. Separation of banking and securities businesses removed such practices.

The Act was repealed in 1999 under pressure from the financial services industry who argued that by preventing diversification, the Act made banks riskier. Overnight, commercial banks, merchant banks and insurance companies merged under the same umbrella, creating financial behemoths. The most famous example was Citigroup, created through the merger of Citibank and the Travellers Group. The subsequent misfortune of Citigroup and other financial omnibuses highlights the relevance of the separation of banks and securities business. China, the new financial powerhouse, still maintains a separation between the two businesses.

As we are still developing our financial markets, we need to take a prudent approach to this issue. Banks should still be allowed to participate in merchant banking, but the practice of banks' margin lending should be limited with a keen eye on regulatory capital requirement. This would stop certain institutions from cornering the market by putting in huge capital in select securities or pulling out; a practice that creates huge volatility.

Also, in order to ensure the growth of independent merchant banks, it must be ensured that mandates such as issue management and underwriting offerings are equitably awarded to these institutions. The government can take a proactive role by selecting independent firms for management of government issues. Currently, Investment Corporation of Bangladesh (ICB) seems to have the sole mandate of such issues, which is not conducive to a competitive market. We need to develop various counter and competitive forces in order to ensure a competitive and efficient market.

The Local Mutual Funds Industry

Recently we observed a heightened interest in the country's capital market surrounding mutual funds. Four new mutual funds have been launched since January 2007 with a target to raise Tk 2.55 billion. Another six mutual funds will be launched within the year and are expected to raise Tk 12 billion.


Most of these funds are sponsored by private financial institutions and offer an alternative to Investment Corporation of Bangladesh (ICB) mutual funds. Mutualisation of investors' fund is an old concept. Initially the goal was to create a large pool allowing investment in large projects. The advancement of investment theories in the 1950s and 60s and an understanding of the benefits of diversification added to the popularity of mutual funds.

Economic growth in developed countries after World War II led to a rapid growth in individuals' savings, which further encouraged a demand for better investment options. As of 2008, worldwide investment in registered mutual funds stood at $21.7 trillion. Although asset under management (AUM) declined from its 2007 peak of $26.2 trillion, this still amounts to a cumulative annual average growth rate of 10 percent over 85 years.

A mutual fund is usually a collection of a few separate companies. At the core is the fund itself whose sole purpose is to raise capital from investors and disbursement of the capital. The ownership of the fund is divided into many units, which are owned by individual investors. The fund is overseen by directors or trustees and managed by a fund manager or an asset management company (AMC). The AMC makes the investment decisions and is paid a fee for its services, usually a percentage of the total AUM.

A security broker executes trade for a fee. A custodian or trust company holds the securities for the fund. There are countless variations of this simple model depending on investment style, asset mix, size of the fund, fee structure, and inclusion or exclusion of new investors.

Net asset value (NAV) of a fund unit represents the share of assets (less any liability) of each unit. There is no reason for a fund to trade above or below its NAV except for temporary or liquidity reasons or unless the NAV calculation is grossly erroneous.

The simple model of the mutualisation of individuals' funds offers a number of advantages. An average trade by a mutual fund is much larger than that of an individual's portfolio lowering overall transaction costs, asset diversification in a large portfolio is easier to attain and mutual funds can spread the cost of investment research over many investors.

The proliferation of institutional investors (mutual funds, private funds or retirement funds) brought some secondary benefits to the investment management industry, like institutional investors through large shareholding can exert strong influence to improve corporate governance of businesses and because of their large resources, institutional investors can take position in unconventional assets. This improves portfolio diversification and aid global capital flow.

The Securities and Exchange Commission (SEC) is responding well to the growth in institutional funds by formulating regulations and guidelines for the AMCs. Based on my experience in the mutual funds industry and my review of the prospectuses of the four latest mutual funds, I shall point out a few issues that are important, requires attention, and needs to be addressed for a healthy growth of the industry.

Expenses and management fee
A fund pays all its expenses and a fee to the AMC from its assets. Size of the expenses and fees affects the performance of a fund. Funds are free to choose their fees subject to the competitive environment. Of the four funds, annual fees ranged between below 1 percent (Grameen Mutual) to 2.5 percent (two ICB NRB) before expenses. The three funds managed by ICB AMCL anticipate annual expenses up to 4 percent of the NAV. Taken together, management fees and expenses can cost as much as 6 percent annually. In comparison, investors in advanced countries pay about 2.5 percent in management expense ratio (MER). Bangladeshi AMCs charge a 'formation fee' between 1 percent and 5 percent at inception, which does not have a parallel in other markets. Because of compounding, high management fees and costs make a sizable dent in the total savings, as shown in the table below. Hopefully management fees will eventually decline as competition grows. For now however, should the funds be allowed to charge high fees simply because they can? I am not recommending regulation of fees, but some balance must be achieved by exact and prominent disclosure of the fees and expenses.

Credentials of a portfolio manager
In the investment management industry, portfolio managers are highly regarded for their knowledge of the profession and the high standards they practise. Portfolio managers must clearly understand and practise certain duties including the duty of care, duty of diligence and duty of a fiduciary. Managers in advanced markets undergo extensive training and licensing requirements. I understand that the SEC of Bangladesh grants a license to an AMC based on the credentials of its professional staff. The following questions should be answered to make the process transparent: is there a clear guideline that states who can be presented by an AMC as a portfolio manager? To what standards should a portfolio manager be held, and how are these standards enforced? The regulator and the market participants should also develop training and licensing programmes for mutual funds distributors, portfolio managers and other market participants. These programmes should focus on industry knowledge and the regulatory, legal and ethical aspects of the business.

Fund objective/style and benchmark
Based on the skills and strength of the AMC, mutual funds adopt an investment style and choose a benchmark based on the style. Fund performances are evaluated with respect to the benchmark. Because of a shallow market, the four listed mutual funds did not specify an investment style. They also did not offer a benchmark that could be used to evaluate their performance. The use of a broad index such as the DSE/CSE indices would assist investors' selection of a mutual fund.

Performance standards
Seasoned investors look at the past performance of a mutual fund when selecting a fund. Standardisation of performance reporting is necessary as AMCs can otherwise paint a rosier picture of their performance by cherry-picking the investment interval and other variables. It is important to establish the basic rules of performance reporting while the industry is still young. The SEC can look at various industry organisations and regulatory bodies that have established uniform performance measurement standards. The CFA Institute advocates use of the Global Investment Performance Standards (GIPS) and makes it publicly available.

Use of unlisted securities a nd their valuation
The last issue of concern is the inclusion of unlisted securities in mutual fund portfolios. All funds allow inclusion of unlisted securities. For our four funds, as much as 50 percent of the securities can be unlisted.

Calculation of the NAV
Valuation of unlisted securities poses a problem as they do not provide a daily closing price. The stated policy for valuation of unlisted securities, including the frequency, process and oversight by trustees, is not very transparent. In other words, AMCs are giving themselves a wide berth in valuing unlisted securities. Impact of the valuation is still more important as calculation of the NAV determines the management fees.

Disclosure of holdings
None of the AMCs make any promise about regular disclosure of their fund holdings. Registered mutual funds in advanced markets are required to disclose their holdings at least quarterly. This disclosure enables investors to monitor whether and how a fund is complying with its stated investment objectives. If a fund consistently trades in unlisted securities, lack of quality and liquidity of such securities can dramatically affect the risk profile of the fund. A mandatory policy of disclosure of portfolio holdings, especially unlisted securities, can reduce such risks.

The author is an investment analyst and the head of research of a Canadian national brokerage and can be reached at AHCapCorp@live.com.