Thursday, June 10, 2010

Conflicts Of Interest: Bursa Malaysia Edition

No, this isn’t about BCorp and the do-they/don’t-they have a new sports betting license. I caught this on Bloomberg yesterday (excerpts, emphasis mine):

Malaysian Exchange Seeks to Lure Individual Investors

June 9 (Bloomberg) -- Malaysia’s bourse said it’s seeking to lure individual investors who have shunned the market a decade after the Asian financial crisis.

Bursa Malaysia Bhd. is working with brokerages and banks to “to reach out to retail investors in various towns and cities” to open up accounts and encourage online trading, Chief Executive Officer Yusli Mohamed Yusoff said in an interview in Kuala Lumpur.

Trading by individuals fell to as low as 20 percent of trading value from more than half before the start of the Asian financial crisis in 1997, when the benchmark index slumped by a record 52 percent.

“A lot of retailers lost a substantial amount,” Yusli said yesterday. The result is that the market is now “dominated by the local institutions,” he said.

Most individual savings started shifting to mutual funds and unit trusts since Malaysia’s economy went into a recession in 1998, Yusli said. They haven’t returned to stock trading even as the economy expanded at an annual average of 5 percent over the past decade and the benchmark index more than doubled...

...The exchange aims to boost the share of trading by individual investors “closer to a third,” tapping Southeast Asia’s second-highest savings rate, Yusli said, declining to give a target date. Malaysians saved 38 percent of gross national income in 2008, lagging behind only Singapore’s 47 percent, according to data compiled by the World Bank and Malaysia’s central bank.

The KLCI’s 45 percent gain last year lagged behind Southeast Asian neighbors even after the government announced stimulus plans totaling 67 billion ringgit ($20 billion) to help pull Southeast Asia’s third-largest economy out of a recession.

Trading slumped by half to an average $375 million a day over the six months ended May from the same period 13 years ago, right before the start of the regional financial crisis in July 1997, according to data compiled by Bloomberg. Neighboring Singapore’s figures have quadrupled to $1.1 billion over that time, data from the city-state’s exchange show...

...The slump in trading by individuals coincided with an exodus by foreigners from Southeast Asia’s second-biggest stock market, leaving Bursa more reliant on domestic institutional funds. Overseas investors have sold a net 1.36 billion ringgit of Malaysia’s equities this year, adding to 8.57 billion ringgit withdrawn in 2009 and 38.6 billion ringgit that flowed out in 2008, according to exchange data. In 2007, they bought a net 24.7 billion ringgit.

The exit left foreigners holding 20.6 percent of local stocks at the end of April, down from 27.5 percent in April 2007, according to stock exchange data. Overseas investors held 9.33 percent of Tenaga Nasional Bhd. at the end of April, compared with 27 percent in April 2007, according to data from Malaysia’s biggest power producer.

The state-controlled Employees Provident Fund accounts for 50 percent of daily trading volume in the equity and bond markets, Prime Minister Najib Razak said on March 30. More than half of the 417.1 billion ringgit of market value in the benchmark stock index is owned by government-linked funds, according to calculations by Bloomberg.

“We’d rather see a more balanced distribution, so that one particular sector doesn’t dominate the market so much,” Yusli said.

Retail investors’ share of trading is low by comparison with at least one neighbor, Thailand, where individuals accounted for 56 percent of turnover so far this year, according to data compiled by Bloomberg. Exchanges in neighboring Indonesia and Singapore don’t track the figures.

I can understand the argument regarding diversifying trading away from EPF. What I don’t get is why target individual investors, if trade diversification is really Bursa’s goal.

Theory suggests that the costs of diversifying portfolio risk is lower when individuals invest via unit trusts, and information costs for individuals are then relegated to just monitoring the fund manager(s) and the overall market, rather than a personal stock portfolio. Menu costs are lower as well, in terms of adjusting the portfolio mix based on market conditions. In addition, institutional funds are (supposedly) better able to handle market volatility and have a better chance to monitor and evaluate individual stocks (with some reservations).

The problem Bursa is facing is that while Malaysia does indeed have a nominally high savings rate, these savings are by private enterprises and not by households. That’s means that Bursa’s effort is probably doomed to fail, and thankfully so – given the reasons I outlined above, there’s not much benefit in aggregate for individual investors to put funds directly into the market. And I’d not be very happy if Bursa started targeting corporate savings either – investing in the stock market should not be part of corporate business activity.

Why I’m calling this a conflict of interest on Bursa’s part is because of their corporatised structure, and because of the benefits that individual investors can bring to market activity. That line about the fall in daily trading volume is key to understanding this – who benefits most from higher trade volume? Stock brokers and by extension, Bursa itself; certainly not individual investors, who tend to be market followers rather than market leaders. The fact that Bursa Malaysia is a publicly listed company and answerable to shareholders means that their incentives are highly skewed toward increasing revenue and profits, rather than safeguarding individual investor interests.

As I say, they aren’t likely to succeed, but the very fact they’re pursuing this course is disturbing.

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