Dr. Sharif Nurul Ahkam :
[This is the second part of the article]
Consider the DSEX index for last one year. The peak was on January 24, 2019. The stock market rise was somewhat euphoric right after the election and it started running out of juice in February. The index value had shown a gain of over 14 percent in just about a month and expecting that trend to continue unabated is not realistic. On an annual basis, that rise was 168 percent. Nobody was unhappy then and it sort of spoiled the players. The technical charts goaded traders to bet more often and more, thinking there was no end to good times. But in the stock market, good times always end. The rapid rise gave way to a correction. If you estimate the one year return from June 18 to May 19, it came to a negative 1 percent. The algorithm of DSEX Index does not capture cash dividend. If you consider the cash dividend paid out which is normally around 4-6 percent, long-term diversified investors actually had a gain of 3-5 percent over this time frame. In Bangladesh stock market, if you play long, it is reasonable to expect 30 percent annual return in spite of all the ups and downs.
But if you want to get rich by trading on a daily basis, and form your investment strategy by remaining fixed on the computer screen, you should be ready for some loss once in a while and 1 percent negative return does not really count as a loss. I have a difficult time understanding why there was such a hue and cry for just a 1 percent negative return in one random year. Should you really be trading in the stock market if you cannot stomach a 1 percent drop in the value of your portfolio? I am more concerned about the fact that the stock market, relative to the historical average, did not produce very good returns over the last few years. If you look at the chart above, the index has remained basically flat over this time phase, and has remained fairly flat for last three years.
In the Working Paper 95 by Center for Policy Dialogue, Moazzem and Rahman (2012) list several questionable activities that make certain stocks move. They mentioned bull cartel and serial trading to lure (I am reluctant to say innocent) market participants into buying stocks at unreasonably high prices, only to see the price drop. I suspect that happens and I am going to blame the SEC and DSE from promoting technical analysis. They teach you how to do technical analysis, and inadvertently, create conditions for setting up these traps. People relying on technical analysis are much more likely to fall in their trap than those who make diversified investment for the long-term based on fundamental analysis. Instead, I would like SEC to develop capabilities to identify bull cartels and serial trading. That would be much better than creating wrong-headed suicidal rules.
Let us consider the damage the proposed measures will do to the market development and industrialisation of the country. We can currently about 12 good IPOs per year and the desire is to raise that to about 18 in the near future. Let us work with the following simple assumptions:
1. There will be 12 companies per year making initial public offers (IPOs).
2. Each company needs Tk 100 crore.
3. 50 percent of the money will be raised through Pre-IPO placements (within one year of IPO), and half of that (25%) will be through controlled IPO (that is pre-IPO lock in for one year).
In this scenario, Pre-IPO investors will shell Tk 600 Crore to ensure the viability of business, and reduce the supply of open issue to hold a reasonable price of the IPOs. If you lower this proportion to 25 percent, you better be certain that there will be buyers to supply the necessary Tk 300 crore to take up the open issue shares without causing a drag on the opening price. You will probably be also jeopardising the viability of the new business.
It is well-known that Bangladesh has severe shortage of capital. Bangladesh also has severe shortage of business entrepreneurs and risk-takers. Nearly $6 billion is laundered out of the country every year, which otherwise could have been available for investment in the country. You disrupt the system to reward those who seek profit on a daily basis and punish those who risk money with all returns on hold for at least one year, you had better be sure that is the right thing to do. The proposal to limit pre-IPO placement limit to 25 percent will be a desirable goal in the future, but at this point, this comes with the presumption that the balance can be raised assuredly from our weak capital market without putting any pressure on the possible open price.
A suggestion to enforce a lock-in for pre-IPO placements for three years is plain crazy. It is not easy to get people to lock in Tk 600 crore per year without any guarantee of any return after a year. A three year lock in will raise the amount to Tk 1,800 crore and the pre-IPO investors will see no return for three years. It will be a pipe-dream to think that, in the present capital market, we will be able to raise that kind of money knowing that it will remain tied up for three years generating no benefit at all. Bank FDR and laundering money out of the country will clearly look more desirable. This is to “guarantee” that traders in the stock market (a very small percentage of the population and a small bit player in industrialisation) have handsome profits on a regular basis with no tax on capital gain to pay. It is a strange logic that day traders profit matter more than who are risking money to build productive facilities without any return for a long stretch of time. The proposed change to a three year lock in will throttle this process of capital formation.
The off-loading is essential in supplying capital for the growing economy of Bangladesh and it is suicidal to try to make it unavailable. Off-loading allows capital to be recycled for new businesses, makes larger amounts available for next cycle of investment, and it also provides a mechanism where common shareholders can participate in the good fortune of a company once the initial risk, uncertainty, and errors in evaluation is behind. Traders in the stock exchanges will never provide capital to companies at the stage where possibilities of fraud, uncertainty, and evaluation errors are at the highest. Without the investment by pre-IPO investors, these opportunities will not be created for common risk-averse investors, and yes, traders who are sure that they can predict the stock price for the next day. The mechanism looks something like the following figure. If you break the process, you eliminate a reliable source of capital for new investments.
And what benefit will it provide to delay off-loading by two years. If the off-loading truly has any significant effect on stock prices (it actually does, but the market must reward the risk-takers), this will be delayed by two years. The effect will not be eliminated and we will eventually have to go through the off-loading process and a prospect of a hit on the particular stock price. The secondary market is supposed to allow off-loading of shares so that money is freed for new investments. The secondary market does not assume any risk at the development stage of a firm, the sponsors and pre-IPO investors do. Given the magnitude of risk and shortage of capital, it is only natural that they will reap higher return than the 30 percent annual return long-term diversified investors are getting from the capital market.
The off-loading process actually brings a discipline to the market. It curbs the appetite for increasingly higher price not backed by fundamentals. Pre-IPO investors are not likely to off-load shares if they feel that they are not getting fair price. If the price falls below the intrinsic value, new buyers should enter the market based on fundamentals. The intrinsic value at this point is much clearer and that should set the price in the market, not market rumor or technical analysis. SEC can play a role here. It is there job to ensure the fundamentals of the company are disseminated in the market in very clear term, without any ambiguity, any hidden but significant information. They have to ensure that directors do not sell more than what they are allowed to and the market is notified of their intentions. They have to keep an eye on earnings management. SEC must also encourage listed companies to maintain decent websites and archive of financial reports.
My final words for this article: A three year lock-in period is suicidal for industrial development and the capital market. Don’t do it. Do things that help build trust in the market, not destroy it.
(Dr. Sharif Nurul Ahkam, Professor of Finance and the Director of Graduate Studies, North South University)
