Real potential of the Colombo stock market: A response

This is in reference to an article titled ‘Real potential of the Colombo stock market’ published in Daily FT on 25 May. 

According to the ‘analyst’ who has  written the article, “There is no doubt and there is near unanimity that overregulation by the previous Securities and Exchange Commission arising from inexperience, lack of knowledge and lack of correct strategies was the prime cause for the market collapse witnessed today.” 

It is up to the SEC to respond to this article but as an investor who has been investing in the market for over 20 years, I want to give a depiction of how so called ‘analysts’ destroyed innocent investors in the market during the last few years. 

According to Investopedia, an analyst is a financial professional who has expertise in evaluating investments and puts together ‘buy,’ ‘sell’ and ‘hold’ recommendations for securities. Analysts are typically employed by brokerage firms, investment advisors, or mutual funds. 

The article written by the ‘analyst’ contains many inaccuracies and misrepresentation of facts and is highly misleading. It also appears to have been written by a person with an agenda and thus chose to remain anonymous or hide his identity. 

The ‘analyst’ blames the SEC for imposing the highly debatable ‘price band’ in 2010. All the investors know what happened during the month of July 2010 and how some share prices moved up extensively without any valid reason. The analyst states that, “At the time the retail market was very active and small investors were earning good profits, without prior notice suddenly eight share and warrants, e.g. Touchwood, Dankotuwa, Blue Diamond, Greg warrants, were suspended from trading and thereafter imposed restriction on movements for 15 days, thereby killing the sentiment of these shares/warrants.” Anyone who goes through the annual reports of these companies will realise the ‘future potential’ of these shares and that there was no fundamental reason for those shares to go up in price. 

The writer states that, “It was widely rumoured that certain high net worth company/companies influenced this decision since one of the affected companies threatened to become the highest cap company due to price appreciation.” 

Any investor can guess which company he is talking about and the brokers who were promoting that company. It is up to the Colombo Stock Exchange, SEC, Accounting Standard Monitoring Board and the other authorities to come out and declare the issues that they had with the relevant company in the recent past. 

I would call what happened in July 2010 as clear manipulation of shares by a handful of brokers and market participants. The analyst says that it is not manipulation. If not, how is it that some share prices go up steeply within few days without any identified reason? 

As investors concerned about the stability of the market, we should blame the SEC for not imposing the price band before August 2010. One needs to question the ‘analysts’ who extensively recommended those shares which moved up by over 100 per cent during those few days by sending daily e-mails to their clients. 

These so called ‘analysts’ recommended investors to buy such shares, stating that some of them will even go up to Rs. 1,000 per share. Who is responsible for the plight of such investors who bought some of those shares after listening to the so called ‘Analysts?’  Did they have general analytical skills to understand that shares with negative NAV or even the shares of loss making companies will not go up to Rs. 1,000 per share?  

The SEC could not be held responsible for pushing share prices up artificially. It was the so called ‘analysts’ who were responsible for that. The SEC should take the blame for not bringing those culprits to books. The time has come for the SEC to take action to control these ‘con analysts.’  

It is also noteworthy to mention here the similarities between the shares included in the table published by the ‘analysts’ and the shares that were manipulated in 2010. In Sinhala, there is a saying that goes ‘puhul hora karen dene.’

The table at the bottom of the page ‘forecasts’ a likely share price in three months for a selection of 17 companies of the analysts’ choosing and extrapolates the same growth in share price for three more consecutive quarters and gives an annualised rate of return. How amateurish can this ‘analyst’ get? Any serious analyst would question such projections as mere conjecture. Yet, in the text, the analyst cites this calculation/forecast as ‘proof’ to make his claims.

The ‘analyst’ further states that, “Major Government funds such as EPF, ETF, insurance, Bank of Ceylon, People’s Bank, NSB etc., should be requested to commence buying of mid cap, speculative shares from the market in a small way on a daily basis without resorting to buying large parcels, which would only help the rich class and would not in any way help the market to improve. It could be the small buying of a share that may even last few months. It is common knowledge that immediately after a large parcel is done, the price drops.” 

The so called ‘analyst’ shows a complete lack of understanding of the principle of investing and fund management. Funds mentioned above should be considered long term investors in the market. Their role is not to support the market nor is it in their best interest to invest in speculative or mid cap stocks. Based on the long term performance of the highly capitalised companies, liquidity, as well as the size of the funds that can be deployed it’s prudent and good common investment logic to invest in large cap stocks. Investing in large caps is the only way to make a meaningful investment for large funds.  Investing in mid cap stocks will be highly speculative and mid cap stocks will defeat the very long term nature of these funds.  The objective of the ‘analysts’ may have been to create another issue for these funds by recommending them to buy highly speculative shares.   

The analyst’s recommendation that EPF, ETF, Insurance, BOC, People’s Bank and NSB as well as unit trusts must be requested to commence buying mid cap speculative shares somewhat betrays his motives and agenda and goes against the stated risk/return objectives and investment policies of these institutions who together are entrusted with the majority of public savings of this country.

The ‘analyst’ has also been unable to understand the difference between trading and active investment. The latter implies that an investor gets into the market at a particular level based on various fundamental assumptions. They then hold this investment until such time that their investment objective has been achieved. The investor then constantly monitors the portfolio for any deviations from the fundamental assumptions and makes portfolio adjustments as seems fit.  

Buying in large parcels also increases the bargaining power of the fund. Active investment is not a buy and forget strategy nor is a trading strategy as advocated by the writer, which is speculative and short term in nature.  The investment strategy suggested by the writer will only help short term speculators and stockbrokers. 

As per the ‘analyst’s’ argument about credit, like in all other markets, a prudent extension of credit to the stock market should be facilitated since excessive credit or margin can represent risks of failure of a stock brokers or a market participant, creation of credit fuelled asset bubbles etc., credit extension should be carefully monitored and regulated by the SEC.

In the article, the analyst suggests that the SEC is doing the bidding of certain groups he variously describes as the rich class, blue chip companies etc. The SEC is the capital market regulator under the Ministry of Finance with sole responsibility to protect all investors from fraud, misrepresentation of facts by listed companies and maintain a fair and transparent trading place for securities. 

The SEC also has been mandated to manage and minimise the systemic risks present in the markets/intermediaries etc. The SEC should take decisions based on these three main objectives in mind. It has been mentioned that in their website too. It also has a duty in educating investors of risks and rewards of buying speculative shares. The analyst should visit the official website of the US Securities and Exchange Commission and see how the SEC has warned investors about ‘penny’ stocks. 

In my opinion, the SEC of Sri Lanka should educate investors extensively on buying into these speculative shares and risks and rewards of these shares. It’s a main responsibility of a regulator. Investors, especially new investors, should know that speculative shares are far more volatile than fundamentally strong stocks.

The analyst points out that the majority of CEOs and senior brokers lack the leadership qualities to provide correct leadership in motivating their subordinates and investors. For reasons known to him, he has not included fathers-in-law of CEOs of broker firms on his list. What are the leadership qualities that he is talking about, not recommending loss making companies for their investors? 

Not recommending companies with negative PER to their clients? He is insulting the majority of CEOs and senior brokers with the assumption that he is ‘the analyst’ of the Colombo stock market. This is by recommending the EPF, ETF, insurance, BOC, People’s Bank and NSB to buy some speculative shares.  It will be interesting to see how many CEOs and senior brokers recommended these speculative shares to their investors. The analyst for sure must be talking about those who did not recommend the said shares and ruined lives and millions of money of innocent investors.  His perception on investor education is strange. In the article he mentions that, “Various seminars are conducted almost every other day regarding manipulation and insider trading, which he claims has become a boring subject today.” If Sanjay Wadhwa at US SEC who initiated the insider trading investigation against Raj Rajaratnam come across our ‘analyst’s’ statement, he will certainly commit suicide.  The analyst also talks about private placements before the IPO. It is true that some so called ‘strategic investors’ sold shares during the first day of trading and booked a profit at the expense of small time investors. The SEC has now imposed restrictions on shares purchased from private placements. But the blame should go to investors and brokers as well. How many investors went through the prospectus and decided not to buy? How many research reports were there cautioning investors? Why were the so called analysts silent at that time?  

This article was written not to back the SEC or paint a rosy picture about the SEC though I personally support some of the decisions and rules imposed by the SEC. It is up to the SEC to respond to this article – ‘Real potential of the Colombo stock market” but for some reason they have not done it so far. They must have thought as an institution, they should not wrestle with a pig. People in glass houses should not throw stones, especially when they are fully naked. 

Mahesh Gunewardena