Co-authored by Asif Khan, CFA and Sajib Hossain, Lecturer of finance at Dhaka University. Original article appeared at Dhaka Tribune Website.
The Bangladesh stock market is still in an infant stage when we consider the maturity of investors, the quality of corporate disclosures and the strength of the regulators. Therefore, it is no wonder that the market in Bangladesh is highly driven by momentum where investors have short holding periods.
In the short run, the market tends to act like a zero sum game. If someone wins, someone else has to lose. This is the perfect situation for the slaughter of small retailers.
Let us go through the problems one by one:
Quality of earnings and financial disclosures:
The first major problem is related to the “quality of earnings” and the level of financial disclosures. Quality of earnings refers to the sustainability and trustworthiness of earnings numbers. At present, other than a handful of listed companies, it is very difficult for knowledgeable investors to trust the financial statements. The blame, to some extent, goes towards the auditing firms. However, the first step in preparing clean and transparent financial statements has to be taken by the companies themselves.
Secondly, the accessibility to financial statements is a big problem in itself. Many of the companies do not have websites, and even if they do, the statements are not uploaded in due time. The solution to this problem is to upload statements in the stock exchange websites.
Without access to trustworthy and timely financial statement it is not possible to do fundamental analysis.
Insider trading refers to the trading of shares by people who have access to material news flow, like earnings and dividends, before they are disclosed to general investors. Examples of such investors would be company management, audit firms, company directors etc. This harms the retail investors who get the news flow only after it has already been priced into the share.
The problem lies in the lack of a strong legal framework, along with the enforcement of such laws. For example, if a person earns Tk10m from insider trading and is fined Tk100 thousand, he will happily pay the fine. Therefore, in order to discourage insider trading, the scale of the punishment has to be increased by a large magnitude. We do realize that the regulators might not have adequate manpower to catch all cases of insider trading. However, even if they could set some examples by penalizing few high profile cases, that should work as an example to others.
Pump and dump strategies:
Next, we have pump and dump strategies. By cornering shares (reducing liquidity) and spreading rumors, some manipulators jack up the stock prices in order to dump their holdings on to the unsuspecting retail investors.
As the stock market is a sensitive issue, regulators and governments are sometimes afraid to take steps against market manipulators for fear of the market coming down. In the short run, that is a possibility. However, in the long run, these steps would be much more beneficial to all the stakeholders.
Lack of knowledge of investors:
The lack of knowledge of retailers, and even some institutional investors, is also a problem. Even today, stock bonus is considered to be something great and causes stock prices to go up significantly. When the target victims are not smart enough and need to rely on rumors to make money, they are likely to lose money in the stock market.
The players who will continue to make money will be the “insider trader” and the “large retailer” because of information and capital advantage. If these guys continue to make money, then someone else will lose it.
Lack of transparency in asset management industry:
The stock market is not for everyone. Not everybody has the time to study or learn it. Therein lays the importance of professional fund management. However, the present state of the managed fund business would deter most of the investors who would like to give funds for professional management.
Before giving funds to a management company, an investor needs to look at its track record, investment strategy, background of fund managers and top holdings. None of this information is available in Bangladesh. However, by not promoting transparency, not only are many investors forced to take a shot at investing by themselves based on rumors, the asset management industry is also not growing as much.
In such a situation, the chances for retail investors to make money will be limited. In the short run, the momentum chasing strategies could work out, but eventually the investor is likely to make losses.
We should not let the stock market turn into another tool for redistributing wealth from the poor to the rich. In a country where saving instruments are limited, the role of the stock market is crucial. Before everything else, we need to focus on corporate governance, minority shareholder rights and quality of auditing.