Facilitating research-based investment

FE Report (June 16, 2011)

Prevention is better than cure - we all know it. At present, this proverb is well-matched for the recent share market crash in Bangladesh. The government is now trying hard for the recovery of the confidence of the small- and medium-sised investors whose hard-earned money has already been stuck in the market. As part of the initiatives - the government has already restructured the Securities and Exchange Commission (SEC), the stock market regulator, and created Bangladesh Fund of Tk 5.0 billion in the form of an open-ended mutual fund to increase the liquidity in the market.

Apart from this, steps for demutualisation of the stock markets have also been taken focusing on bringing transparency in management and strengthening the operation of the markets through ensuring agency services. Such recommendations were made by the probe committee on the scam in the stock market in its report. One recommendation is, however, still ignored - the advisory services, the research services for the investors under which the SEC accredited or authorised analysts who can recommend a sale, hold or buy rating, after performing a rigorous analysis.

Under the provisions of the current securities-related ordinance, act, rules and regulations, no one can do this. As a result, small investors depend highly on the rumours and speculations during the bubble formation, and tricky inventors successfully come out of the market after price manipulation.

Stock markets in the world had already experienced the consequences of market crash and are now trying to prevent the bubble formation, because once you have a bubble - there must be a burst. We see the same in our capital market - the first in 1988, second in 1996 and the third in 2010. It is very disappointing to see that our regulators are eager to take the credit for the boom, but blame each other when the market crashes.

The recent crash of Bangladesh stock market is a big blow to small investors, most of them are young and unemployed. They rely heavily on stock market in an effort to augment their incomes to cope with the rising inflation that the country is now facing. Although artificial rise of stock prices is never a good sign for the economy, but a sudden fall of market is equally damaging.

The authorities should have thought of the consequences of their decisions, prior to applying the same. The way it was done and implemented had serious repercussions on stock market and still the business community and analysts are continuously blaming the regulators. They should have done it slowly and gradually. It is still unclear how much time and effort is required for the Bangladesh stock market to recover from this shock.

In western countries, stock market regulators always try to prevent bubble formation through different kinds of measures such as strengthening coordination between money market and capital market. This is because liquidity directly impacts on the operation of stock market, as the financial institutions including banks, non-bank financial institutions (NBFIs) and insurance companies are the major participants in the markets. The regulators also take policy prescriptions, based on the advice of their in-house research department and, therefore, preventive measures are backed by a rationale.

In addition, independent capital market research houses, under the accreditation of the SEC, can recommend investors a rating to buy, sell or hold the individual securities for their portfolio. Surprisingly, this is not allowed in Bangladesh. But, there are 1,100 Cost and Management Accountants (CMAs), 1,200 Chartered Accountants (CAs), around 40 Chartered Financial Analysts (CFAs) and a large number of finance professionals in the universities in the country now. Such professionals are capable of providing advisory services to the investors through proper analysis of the state of affairs, and valuation of assets, relating to the companies.

The SEC should allow them to provide advisory services to the investors under a legal framework so that they cannot involve in fraudulent activities that may hurt the interest of the investors. In addition, the regulator can accreditate or authorise some of the research houses to work as capital market advisers and brokerage houses can outsource researches for their clients. Research products are naturally of high price for individual investors which may be difficult to buy. In this situation, the houses can buy the research products and they will recoup the money by charging the clients a nominal amount of say, Tk 10 based on their client base. These products will provide investors with good suggestions, induced by technical analysis and news-flow analysis.

Investing in the stock market requires a close understanding of the financial market. A profitable trade requires a good source of financial information, analysis, research and trading advice. Most of our retail investors have lacking in that. That is why our market remains prone to schemes and scams. Ordinary investors rely on rumours, as they have no other way to process the public information. It is also very difficult, even impossible, for the retail investors to possess that kind of knowledge and expertise. So, it is better for all the participants that the research houses are allowed to share their thorough and disciplined analysis with all. The research houses will help clients with informed equity investment decisions and build a healthy portfolio, giving the best to one's investment and trading needs. In addition, they will provide successful investment ideas which help create wealth and offer investment advice with a price target and in a timeframe over which gains can be made and also offer views on the economy, policy changes and government initiatives. They can provide reports on unique market opportunities and views on various sectors and their constituents.

At present, Mindspring Research, an independent equity research house, founded in 2009, with the aim of producing high quality research products and services, as private circulation, for some of the brokerage houses and asset management companies. But it cannot recommend, as per the existing law, to the investors on matters relating to 'buy, hold or sell' stocks. In this context, the SEC should look into the recommendations of the probe committee about the advisory services. This can provide one of the preventive measures for protecting stock market from the unwanted crash. We are already far behind other countries. In 1996, India had more than 300 financial analysts, whereas, at that time Bangladesh had none.

Today in western countries, thousands of research firms are producing equity and valuation notes, focusing on comparisons of the derived calculated value with the prevailing market price, which indicates the probable investment action - Hold, Buy, or Sale. In addition, such firms project the fair value of an individual stock through applying an appropriate valuation model, identify the value drivers of a company and evaluate their changes, analyse its earning power, considering various aspects of profitability including competitiveness, management, market segment, and industry cycle, and highlight major risks involved in investment in a company. They also make sectoral analysis which highlights the performance of the industry and future growth, shows the inter-competitiveness of the companies in the industry, determines stages of growth of the industry, identifies high performing companies of the industry, future challenges and points out secondary market performance of the industry.

In this backdrop, all concerned would look forward to the actions by the reconstituted SEC on the research firms in Bangladesh. If the research services are made relevant to the investors and appropriate provisions are made through rules, regulations and legal framework for use of such services, it may prevent the unusual market crash in future.