Opening the stock market just to provide liquidity – without working towards upgrading our information technology infrastructure and reassuring investors about downside risk – will only prove detrimental in the long run
Ray Dalio, the founder and co-CIO of Bridgewater Associates, the world's largest hedge fund, is deemed by many to be the ideal investor in times of crisis. His "all-weather portfolio" approach – to weathering out any storm by providing steady returns to his clients – has made Bridgewater what it is today. The allocation is simple:
- 30% in stocks
- 40% in long term bonds – preferably government treasuries
- 15% in intermediate bonds
- 7.5% in gold
- 7.5% in commodities – besides gold
Regardless of whether or not an economy is inflationary or deflationary, the all-weather approach ensures investors of adequate risk protection.
However, does an average investor running around the Motijheel area have access to these options via the Dhaka Stock Exchange (DSE)? The answer, unfortunately, is no. Ever since its inception, our capital markets have been solely dependent on one financial instrument: equities. Companies regardless of their stature, float shares on the DSE and raise funds to improve their capacity for the long run. The shareholders keep looking at the sky, expecting a downpour of money, enough to keep their next generations flooded with unlimited bounty.
But reality soon hits them hard, as they continue to witness their holdings being downgraded, receiving nothing but pieces of paper labelled as dividends, with little to no capital gains.
The risk with an all-equity market is that it provides no downside risk-protection. Globally, whenever investors expect the markets to go down, they hedge their positions via put options or switch into gold and/or government bonds.
Our capital markets do have a small subsection of listed government bonds, but they are not something the small retail investor can acquire due to illiquidity and high unit prices. High-interest rate savings accounts and FDRs are therefore what most resort to in dire circumstances – despite living with the fear of banks going bankrupt!
So, what are the avenues through which we can entice new investors? The answer is there are none. The only passive investment vehicles available are mutual funds, which provide little diversification benefits as they, too, can mostly invest in equities. The absence of ETFs and index funds does not help either, and a lack of derivatives makes matters even worse.
While the DSE continued to remain shut, it begged the question, "Should it reopen at all, given the fundamental flaws surrounding it?" Investors have been fighting a losing battle all along. Non-existent diversification benefits, a lack of corporate governance, and a large crowd following the "euphoric madness" with little financial literacy can never form the basis of a fully-functional, efficient market.
The Philippine Stock Exchange suspended operations for a couple of days due to the novel coronavirus pandemic on March 17 and reopened shortly afterwards, while the Colombo and Dhaka stock exchanges continued to remain out of service until recently. No major bourse shut down operations for more than eight consecutive weeks. Even India's Bombay Stock Exchange Ltd was running a fully-fledged operation – not to mention the likes of New York, London and, even the Karachi stock exchanges.
All these major exchanges not only provide the option to invest in various financial instruments, but also guarantee the availability of a smooth, online trading platform where investors can place their trades from the comfort of their homes. As our brokerage houses continue to accommodate ghosts, investors sitting at home can place their buy/sell orders directly within the tap of a button.
Our trading platforms and settlement systems are not exactly fully-automated. Although DSE's Flex Trade is a hundred percent real-time trading platform, conventional investors have not been provided ample training to use such types of devices. They prefer the surety of placing their trades over-the-counter and via the telephone.
Turnover generated by the online platform hardly accounted for five to six percent of total trading volume over the last few months, even in a dry market. Whereas the Shanghai & Shenzhen Stock Exchanges, the strategic partner of DSE, have more than 95 percent of their trades placed through online trading platforms.
Due to the current pandemic, the regulators should have contemplated updating rules and strategies to attract new investors into the market. Implementation of a floor price was a step in the right direction; however, its effects are yet to be seen. A similar experiment by the Karachi Stock Exchange, in 2008 during the global financial crisis, did prevent an excessive drop in the market index but dried up liquidity initially. Once the floor was removed, the prices of most stocks decreased rapidly and volatility increased significantly.
A focus on letting our financial institutions invest in foreign stock holdings will only encourage foreigners to invest more in our markets. Albeit, capital flight is a concern, but the merits of international diversification have been shown to far outweigh the perils of poor corporate governance of failing to track capital flight to tax havens like Panama. Most ETFs and mutual funds around the world invest in foreign companies listed in the US, UK, Singapore and even Vietnam stock exchanges. The emerging market funds may be volatile but have been known to magnify returns significantly if stocks are acquired after thorough due diligence.
For example, Yale University's endowment fund as of June 30, 2019, had an allocation of 2.7 percent in domestic equities vs. 13.7 percent in foreign equities. Many high-growth companies exist in the venture capital, private equity and foreign equity space – to which our capital markets are still not accustomed. Section 2A(1) of the Bangladesh Securities and Exchange Ordinance, 1969, states, "No issuer, or no company incorporated in Bangladesh shall, except with the consent of the Commission, make an issue of capital outside Bangladesh." Such provisions have restricted the opportunities for mutual funds and other investment vehicles to make a substantial investment in prospective foreign companies on behalf of their unitholders.
In addition to that, investment options like gold or gold bonds are yet not available to local investors to hedge their portfolios. Gold is seen as a safe haven during times of financial uncertainty and its unavailability has only continued to hamper investor returns over the years. Gold and other commodities are no longer assets for the wealthy elites and government officials, as investors in developed economies have the option of Gold ETFs or bullion gold which provide returns similar to holding an amount of gold over a designated period.
While we are struggling with the basics of automation, our neighbouring country, India has all of the above options available at their disposal, which is one of the reasons they have been able to draw in both foreign direct investment and foreign portfolio investment.
However, these are all the instruments available in a fully-functional capital market. What we have currently is a stock market of unpromising returns filled with sharks ready to gobble up the small, retail investors. It will be a miracle in itself if the existing investors have the option of designing an all-weather portfolio during their lifetime. While there are major concerns about being kicked out of the MSCI global index, ensuring transparency and information technology infrastructure in trading operations shall be a good enough start in the current circumstances.
Sayeed Ibrahim Ahmed, an investment analyst, and alumni of both the University of Toronto and Imperial College London. He is currently a Senior Lecturer of Finance at American International University Bangladesh (AIUB) pursuing research along the lines of capital markets and economic policy