Despite the prevailing global pandemic and its adverse impacts in the local economy, the Colombo Stock Exchange (CSE)’s resilience to pandemic-related shocks has been quite impressive in the past few weeks.
By mid-October, the stock exchange managed to pull a turnover for the year that was higher than the annual turnovers the CSE managed to achieve in the last five years. In fact, on Thursday (5), the All Share Price Index (ASPI) of the CSE surpassed the 6,000 mark.
Surprisingly, this impressive performance has been amidst sustained net foreign selling, which by mid-October was over Rs. 43 billion for 2020. The recent market boom has been mainly attributed to increased domestic investor activity in the stock market since the reopening of the country in mid-May.
For a stock market that has set new records, led mainly by local investors, one might wonder whether the CSE needs foreign investors; whether it cannot sustain relying almost entirely on local investors. The Sunday Morning Business this week takes a look at foreigners at the CSE, their contribution to our stock market’s performance, and the level of importance of their presence at the CSE, whilst also focusing on foreigners' contributions in selected international stock exchanges.
Post-lockdown at CSE
Immediately after the reopening of the country in mid-May, following a seven-week long lockdown, the CSE suffered significant net foreign losses mainly due to lost confidence on the Sri Lankan stock market. The lost confidence was mainly due to foreign investors being deprived of the opportunity to pull out their investments when they originally wanted to, during the seven-week long closure of the market throughout the curfew period. Nevertheless, there was keen domestic buying interest from bargain hunters looking to snap up fundamentally sound stocks that were on offer at 10-year low prices.
The following weeks were weeks to savour for domestic investors who were on the lookout for bargains, with shares of the leading listed banks and premier blue chip John Keells Holdings PLC (JKH) closing trading below the Rs. 100 mark, for the first time since 2009.
According to seasoned market watchers, the last occasion all these stocks fell below the Rs. 100 mark was back in 2008 when the ASPI crashed 41% following the Seylan Bank and Sakvithi scandals and the 2007/2008 global financial crisis. They hovered around those prices till around the time the war ended.
Stockbrokers are raking in big bucks. In fact, earnings have been so high that stockbroking companies rapidly made up the revenue they lost due to the prolonged closure of the market. Even though foreign selling remains sustained, there has been high interest from domestic high-net-worth individuals and institutional investors who have been picking up fundamentally stable stocks at a bargain due to the departure of foreign investors.
The volume of securities held by the foreigners at the Central Depository System (CDS) of the CSE has dropped by 641.8 million up to October this year while securities held by domestic investors has increased by a remarkable 15.77 billion.
As of end-October, total securities held by both foreigners and locals stood at 114.33 billion, compared to 99.2 billion on 31 December 2019. In October, 26.22 billion securities were held by foreigners compared to 26.86 billion in December while the rest of the 88.11 billion in securities were held by locals compared to 72.33 billion as of end-December.
Best-performing stock market
Despite external shocks, the benchmark ASPI of the CSE recorded significant gains, outperforming all other main indexes around the globe during the month of September. The ASPI gained 12% in September and in value terms, by Rs. 279.6 billion. The S&P SL20 Index, which features the CSE’s 20 largest and most liquid stocks, also gained in
September by 4.39%, closing at 2,463.27 points as of 30 September.
The average number of trades carried out in a trading day during the month of September was 20,607, which was 96% higher than the Year-to-Date (YTD) average number of trades done per day indicating a significant improvement in trading activity and investor engagement during September. In terms of market turnover, a Rs. 50 billion consolidated turnover was recorded during the month of September. This is all amidst sustained net foreign selling.
YTD turnover higher than overall turnover of 2019
Even though the ASPI of the CSE on 5 October recorded the highest drop in a single day in history after the country reported the first case of Covid-19 community infection in several months, by mid-October, YTD turnover of the CSE was Rs. 259 billion, the highest in the last five years. These turnover figures are despite there being a whole two months remaining to end the year. This is due to bullish local investors who have been absorbing shares that are being let go by foreigners.
Foreigners at CSE
Sri Lanka’s stock market is a frontier market similar to countries like Vietnam, Pakistan, and Bangladesh in the region. Frontier markets are more established than Leased-Developed Countries (LDCs) but still less established than the emerging markets. Frontier markets are considered desirable by investors looking for substantial long-term returns since these markets have the potential to grow much more stable and established over the course of decades. Financial experts agree that frontier-market equities offer the best prospects. These markets, which are at an earlier stage of development than emerging markets, are characterised by strong economic growth and tend to pay high dividends.
According to Forbes, there is a strong positive correlation between US equities and India’s, based on the last five years of market data. Sri Lanka, on the other hand, has a negative correlation with both markets. This offers strong diversification to investors amidst global volatilities.
Before 2008, in the final years of the 27-year long civil war, the perception of the CSE among foreign countries was not favourable due to the ongoing war situation in the country. As a result, international participation in the CSE was very limited. Nevertheless, foreign investors quickly accounted for a considerable share of CSE capitalisation following the end of the war and even today, a considerable proportion of CSE investors comprise foreign investors, both individual and institutional.
Foreigners this year
During the first quarter of this year, foreign companies’ inflow into the CSE was Rs. 30 billion while its outflow was Rs. 35 billion. Meanwhile, inflow from foreign individuals during this period was Rs. 416 million and outflow was Rs. 179 million. Overall, the first quarter reported net foreign outflow of Rs. 5.42 billion.
However, the CSE was closed for trading in the last two weeks of March, after the S&P SL20 Index, which includes the 20 largest companies by total market capitalisation listed on the CSE, dropped by 5% several times, triggering 30-minute halts in regular trading during the week that began on 16 March.
The following week it remained closed for four days with the Government declaring holidays. It was opened on 20 March, only to close shortly after opening. Since then, the CSE remained closed until 11 May.
Even before the first half of this year, net foreign outflows from the CSE were over Rs. 18 billion, due to increased selling due to the local outbreak of the pandemic. The CSE continued to suffer foreign outflows and in September alone it recorded a net foreign outflow of Rs. 8.08 billion compared to Rs. 8.06 billion a month prior. Net foreign outflows in the month of September and August were significant as net foreign outflows reported in July were a comparatively better Rs. 3.35 billion.
However, given the achievements of the CSE in the recent weeks, despite foreigners selling their stocks, one could question whether Sri Lanka should worry about them leaving.
The importance of foreign investors
Advocata Institute and JB Securities Chairman and former CSE Director Murtaza Jafferjee told The Sunday Morning Business that domestic investors have to be the backbone of any market. Nevertheless, he emphasised the importance of having foreign investors.
Jafferjee stated that typically most foreign investors are large global fund management firms and they allocate capital across many markets. Therefore, their participation in our market makes them the marginal investor.
“Generally the marginal investor improves price efficiency and pushes for higher standards in gatekeeping, i.e. rating agencies, buy and sell side research, etc. to improve their standard. Furthermore, the larger firms can tap global capital to meet capital raising requirements for large infra projects and regulatory capital for our big banks,” he added.
Increased FDIs
The proportion of foreign investors in the CSE brings a number of benefits to the Sri Lankan economy. According to D.A.I. Dayaratne from the Department of Accountancy and Finance of the Faculty of Management Studies at the Sabaragamuwa University of Sri Lanka, these benefits include increased market competitiveness and accurate pricing of the stocks when more foreign participants are involved.
Dayaratne in a research paper states that the most important economic benefit is that the economy gets more Foreign Direct Investment (FDI) through the capital market which leads to the increase in productivity in the economy as public companies’ wealth and the asset structure is growing under this condition.
This could be explained by the fact that two weeks ago, Zimbabwe launched its second stock exchange to shield investors from currency instability and exchange control risks and also to lure more foreign investors.
The new stock exchange, Victoria Falls Stock Exchange came at a time when foreign investors were increasingly selling off stocks listed at the country’s main stock exchange, Zimbabwe Stock Exchange. The selling off was due to foreign investors taking advantage of a foreign currency auction trading system that was introduced in June this year, which permitted long-trapped investments in Zimbabwe to be repatriated. Investors were struggling to remit capital since 2016, following a directive issued by their Central Bank prioritising certain transactions in all foreign payments. Zimbabwe hopes that the new stock exchange would be a conduit for foreign portfolio investments and FDIs.
In terms of Sri Lanka, FDIs are of paramount importance, firstly because it could accelerate Sri Lanka’s arrival at upper middle-income country status. Secondly, it could enable the introduction of new technologies and innovative ways of production and service provisions. Thirdly, it could boost exports and can help with the trade balance as Sri Lanka has had persistent problems with its trade deficit, according to the World Bank (WB).
Improved market efficiency
In addition to this, foreign investors enhance the flow of capital into the country, maintain, and even improve the capital structures of the companies they are investing in. They help with the financial innovation of capital markets.
In a move to increase the market efficiency and to expand the institutional investment base, Saudi Arabia last year relaxed a 49% limit for foreign strategic investors in shares of listed companies to attract billions of dollars through a diversified investor base. According to the Arabian authorities, there will be no minimum or maximum ownership limit, however, owners must hold onto shares for a minimum period of two years before they can sell.
Transparency and accurate stock price information
Jafferjee noted that foreigners in a stock market force standards to be improved in terms of market infrastructure, regulation, and liquidity, which benefits all investors.
Meanwhile, an article in the North American Journal of Economics written by Elsevier BV states that foreign investors accelerate the incorporation of common information into the prices of stocks, mainly due to their superior skills in processing systematic market-wide factors.
However, Elsevier found evidence of optimality in foreign shareholding, suggesting that the efficiency benefit disappears after foreign ownership exceeds a certain threshold level.
Another set of international economists state that foreign investors could help improve stock price information efficiency indirectly via enhanced corporate governance. Specifically, foreign institutional investors can play an important disciplinary role of monitoring their portfolio companies in the presence of expropriation by large shareholders.
“It is a widely accepted fact that for a smooth running of the stock markets, whether in developed countries or developing countries, market regulation plays a pivotal role in enhancing the investor confidence. It is essential to have transparency in the regulation for a market to perform well,” Dayaratne added.
According to the International Monetary Fund (IMF), more transparency can be beneficial both in attracting investment and in helping to avoid excessive volatility of capital flows while enhancing the orderly and efficient functioning of financial markets. Transparency reduces the occurrence of phenomena such as herding (where investors make certain decisions merely because they observe others making them), waves of investment flows driven by sentiment, and investor overreaction to news.
What can Sri Lanka do?
Sri Lanka might be able to record historically high turnovers driven mainly by domestic investors and take excessive pride in it, but for improved market efficiency and transparency, foreign investors are essential. Since foreign investors are fleeing the stock exchange, it should focus on measures to lure them back.
However, some economists claim that foreign investors drive the fortune of big companies in which they invest. But their buying and selling of securities have a huge impact on the stock market. The smaller companies are taken along for the ride. In addition to this, these foreign investors seek only short-term returns. When they pull their investments, banks can face a shortage of funds. Therefore, like Saudi Arabia, Sri Lanka could introduce regulations making it mandatory for an owner to hold onto shares for a specified period of time before they could sell off.
Or else, it could provide country membership programmes, similar to that of Thai Elite Card which offers stimulus plans through membership benefits to lure more investors. The cardholders get opportunities to invest in the country’s bonds and stock market while also receiving a number of concessions and benefits from the Thai Government. The concessions will be revoked if a cardholder discontinues their investment in Thailand.
While Sri Lanka’s stock market has been sustaining in the recent past mainly from the domestic investors, a healthy balance of domestic and foreign investors is required. Therefore, Sri Lanka has to take measures to mitigate excessive foreign investors fleeing, and it is a major economic concern which requires immediate attention.
Post-lockdown at CSE
Immediately after the reopening of the country in mid-May, following a seven-week long lockdown, the CSE suffered significant net foreign losses mainly due to lost confidence on the Sri Lankan stock market. The lost confidence was mainly due to foreign investors being deprived of the opportunity to pull out their investments when they originally wanted to, during the seven-week long closure of the market throughout the curfew period. Nevertheless, there was keen domestic buying interest from bargain hunters looking to snap up fundamentally sound stocks that were on offer at 10-year low prices.
The following weeks were weeks to savour for domestic investors who were on the lookout for bargains, with shares of the leading listed banks and premier blue chip John Keells Holdings PLC (JKH) closing trading below the Rs. 100 mark, for the first time since 2009.
According to seasoned market watchers, the last occasion all these stocks fell below the Rs. 100 mark was back in 2008 when the ASPI crashed 41% following the Seylan Bank and Sakvithi scandals and the 2007/2008 global financial crisis. They hovered around those prices till around the time the war ended.
Stockbrokers are raking in big bucks. In fact, earnings have been so high that stockbroking companies rapidly made up the revenue they lost due to the prolonged closure of the market. Even though foreign selling remains sustained, there has been high interest from domestic high-net-worth individuals and institutional investors who have been picking up fundamentally stable stocks at a bargain due to the departure of foreign investors.
The volume of securities held by the foreigners at the Central Depository System (CDS) of the CSE has dropped by 641.8 million up to October this year while securities held by domestic investors has increased by a remarkable 15.77 billion.
As of end-October, total securities held by both foreigners and locals stood at 114.33 billion, compared to 99.2 billion on 31 December 2019. In October, 26.22 billion securities were held by foreigners compared to 26.86 billion in December while the rest of the 88.11 billion in securities were held by locals compared to 72.33 billion as of end-December.
Best-performing stock market
Despite external shocks, the benchmark ASPI of the CSE recorded significant gains, outperforming all other main indexes around the globe during the month of September. The ASPI gained 12% in September and in value terms, by Rs. 279.6 billion. The S&P SL20 Index, which features the CSE’s 20 largest and most liquid stocks, also gained in
September by 4.39%, closing at 2,463.27 points as of 30 September.
The average number of trades carried out in a trading day during the month of September was 20,607, which was 96% higher than the Year-to-Date (YTD) average number of trades done per day indicating a significant improvement in trading activity and investor engagement during September. In terms of market turnover, a Rs. 50 billion consolidated turnover was recorded during the month of September. This is all amidst sustained net foreign selling.
YTD turnover higher than overall turnover of 2019
Even though the ASPI of the CSE on 5 October recorded the highest drop in a single day in history after the country reported the first case of Covid-19 community infection in several months, by mid-October, YTD turnover of the CSE was Rs. 259 billion, the highest in the last five years. These turnover figures are despite there being a whole two months remaining to end the year. This is due to bullish local investors who have been absorbing shares that are being let go by foreigners.
Foreigners at CSE
Sri Lanka’s stock market is a frontier market similar to countries like Vietnam, Pakistan, and Bangladesh in the region. Frontier markets are more established than Leased-Developed Countries (LDCs) but still less established than the emerging markets. Frontier markets are considered desirable by investors looking for substantial long-term returns since these markets have the potential to grow much more stable and established over the course of decades. Financial experts agree that frontier-market equities offer the best prospects. These markets, which are at an earlier stage of development than emerging markets, are characterised by strong economic growth and tend to pay high dividends.
According to Forbes, there is a strong positive correlation between US equities and India’s, based on the last five years of market data. Sri Lanka, on the other hand, has a negative correlation with both markets. This offers strong diversification to investors amidst global volatilities.
Before 2008, in the final years of the 27-year long civil war, the perception of the CSE among foreign countries was not favourable due to the ongoing war situation in the country. As a result, international participation in the CSE was very limited. Nevertheless, foreign investors quickly accounted for a considerable share of CSE capitalisation following the end of the war and even today, a considerable proportion of CSE investors comprise foreign investors, both individual and institutional.
Foreigners this year
During the first quarter of this year, foreign companies’ inflow into the CSE was Rs. 30 billion while its outflow was Rs. 35 billion. Meanwhile, inflow from foreign individuals during this period was Rs. 416 million and outflow was Rs. 179 million. Overall, the first quarter reported net foreign outflow of Rs. 5.42 billion.
However, the CSE was closed for trading in the last two weeks of March, after the S&P SL20 Index, which includes the 20 largest companies by total market capitalisation listed on the CSE, dropped by 5% several times, triggering 30-minute halts in regular trading during the week that began on 16 March.
The following week it remained closed for four days with the Government declaring holidays. It was opened on 20 March, only to close shortly after opening. Since then, the CSE remained closed until 11 May.
Even before the first half of this year, net foreign outflows from the CSE were over Rs. 18 billion, due to increased selling due to the local outbreak of the pandemic. The CSE continued to suffer foreign outflows and in September alone it recorded a net foreign outflow of Rs. 8.08 billion compared to Rs. 8.06 billion a month prior. Net foreign outflows in the month of September and August were significant as net foreign outflows reported in July were a comparatively better Rs. 3.35 billion.
However, given the achievements of the CSE in the recent weeks, despite foreigners selling their stocks, one could question whether Sri Lanka should worry about them leaving.
The importance of foreign investors
Advocata Institute and JB Securities Chairman and former CSE Director Murtaza Jafferjee told The Sunday Morning Business that domestic investors have to be the backbone of any market. Nevertheless, he emphasised the importance of having foreign investors.
Jafferjee stated that typically most foreign investors are large global fund management firms and they allocate capital across many markets. Therefore, their participation in our market makes them the marginal investor.
“Generally the marginal investor improves price efficiency and pushes for higher standards in gatekeeping, i.e. rating agencies, buy and sell side research, etc. to improve their standard. Furthermore, the larger firms can tap global capital to meet capital raising requirements for large infra projects and regulatory capital for our big banks,” he added.
Increased FDIs
The proportion of foreign investors in the CSE brings a number of benefits to the Sri Lankan economy. According to D.A.I. Dayaratne from the Department of Accountancy and Finance of the Faculty of Management Studies at the Sabaragamuwa University of Sri Lanka, these benefits include increased market competitiveness and accurate pricing of the stocks when more foreign participants are involved.
Dayaratne in a research paper states that the most important economic benefit is that the economy gets more Foreign Direct Investment (FDI) through the capital market which leads to the increase in productivity in the economy as public companies’ wealth and the asset structure is growing under this condition.
This could be explained by the fact that two weeks ago, Zimbabwe launched its second stock exchange to shield investors from currency instability and exchange control risks and also to lure more foreign investors.
The new stock exchange, Victoria Falls Stock Exchange came at a time when foreign investors were increasingly selling off stocks listed at the country’s main stock exchange, Zimbabwe Stock Exchange. The selling off was due to foreign investors taking advantage of a foreign currency auction trading system that was introduced in June this year, which permitted long-trapped investments in Zimbabwe to be repatriated. Investors were struggling to remit capital since 2016, following a directive issued by their Central Bank prioritising certain transactions in all foreign payments. Zimbabwe hopes that the new stock exchange would be a conduit for foreign portfolio investments and FDIs.
In terms of Sri Lanka, FDIs are of paramount importance, firstly because it could accelerate Sri Lanka’s arrival at upper middle-income country status. Secondly, it could enable the introduction of new technologies and innovative ways of production and service provisions. Thirdly, it could boost exports and can help with the trade balance as Sri Lanka has had persistent problems with its trade deficit, according to the World Bank (WB).
Improved market efficiency
In addition to this, foreign investors enhance the flow of capital into the country, maintain, and even improve the capital structures of the companies they are investing in. They help with the financial innovation of capital markets.
In a move to increase the market efficiency and to expand the institutional investment base, Saudi Arabia last year relaxed a 49% limit for foreign strategic investors in shares of listed companies to attract billions of dollars through a diversified investor base. According to the Arabian authorities, there will be no minimum or maximum ownership limit, however, owners must hold onto shares for a minimum period of two years before they can sell.
Transparency and accurate stock price information
Jafferjee noted that foreigners in a stock market force standards to be improved in terms of market infrastructure, regulation, and liquidity, which benefits all investors.
Meanwhile, an article in the North American Journal of Economics written by Elsevier BV states that foreign investors accelerate the incorporation of common information into the prices of stocks, mainly due to their superior skills in processing systematic market-wide factors.
However, Elsevier found evidence of optimality in foreign shareholding, suggesting that the efficiency benefit disappears after foreign ownership exceeds a certain threshold level.
Another set of international economists state that foreign investors could help improve stock price information efficiency indirectly via enhanced corporate governance. Specifically, foreign institutional investors can play an important disciplinary role of monitoring their portfolio companies in the presence of expropriation by large shareholders.
“It is a widely accepted fact that for a smooth running of the stock markets, whether in developed countries or developing countries, market regulation plays a pivotal role in enhancing the investor confidence. It is essential to have transparency in the regulation for a market to perform well,” Dayaratne added.
According to the International Monetary Fund (IMF), more transparency can be beneficial both in attracting investment and in helping to avoid excessive volatility of capital flows while enhancing the orderly and efficient functioning of financial markets. Transparency reduces the occurrence of phenomena such as herding (where investors make certain decisions merely because they observe others making them), waves of investment flows driven by sentiment, and investor overreaction to news.
What can Sri Lanka do?
Sri Lanka might be able to record historically high turnovers driven mainly by domestic investors and take excessive pride in it, but for improved market efficiency and transparency, foreign investors are essential. Since foreign investors are fleeing the stock exchange, it should focus on measures to lure them back.
However, some economists claim that foreign investors drive the fortune of big companies in which they invest. But their buying and selling of securities have a huge impact on the stock market. The smaller companies are taken along for the ride. In addition to this, these foreign investors seek only short-term returns. When they pull their investments, banks can face a shortage of funds. Therefore, like Saudi Arabia, Sri Lanka could introduce regulations making it mandatory for an owner to hold onto shares for a specified period of time before they could sell off.
Or else, it could provide country membership programmes, similar to that of Thai Elite Card which offers stimulus plans through membership benefits to lure more investors. The cardholders get opportunities to invest in the country’s bonds and stock market while also receiving a number of concessions and benefits from the Thai Government. The concessions will be revoked if a cardholder discontinues their investment in Thailand.
While Sri Lanka’s stock market has been sustaining in the recent past mainly from the domestic investors, a healthy balance of domestic and foreign investors is required. Therefore, Sri Lanka has to take measures to mitigate excessive foreign investors fleeing, and it is a major economic concern which requires immediate attention.