Financial literacy is key for stock market investors

Sanjeevi JAYASURIYA

The Colombo Stock Market is maintaining its position as one of the best performing markets in the world. However, the retail investor base is very low and the market needs to widen this base to enable large number of new entrants to the market to keep it momentum. There are a few questions that retail investor needs answers such as, is it a good time to invest in the stock market? How can you get an informed decision on appropriate investment?

It is expected that the Colombo Stock Market will come down to a more realistic value as no market can sustain the kind of returns that the Colombo Stock Exchange (CSE) provided over the past two years.

Daily News Business interviewed Sri Jayewardenepura University Finance Professor Dr. Harendra Dissabandara for his comments on the current position of the stock market and what an investor needs to do.

Here are the excerpts of the interview.

Considering the current market conditions and based on the data pertaining to CSE, the stock market performance between 2000 to 2010, it is clear that the month of September has been the most attractive month in terms of market performance.

September is a good month for investors compared to the last two to three months. However, it is expected that market participants will behave in the market wisely and with a positive mind.

We expected September to be the best month this year too, but it did not come out as such. The market recorded negative return contrary to our expectations.

Based on my previous research I think there is a moderate improvement as far as the level of response by the market participants to availability of information is concerned.

Q. What are the reasons for low retail investor participation at the market?

A. Many retail investors purchase shares at a higher price than the actual price. This is mainly due to lack of financial literacy. Even though learning about investment strategies takes a little time it will help the investors to take an informed decision. Unfortunately majority of retail investors are not patient enough to take that extra time to evaluate their trading decisions to make a wise investment transaction.

Instead I feel that some of the investors' only basis for their decision is word of mouth. I personally believe that this is the weakest method. As at times, compared to their real value, prices seem to be unrealistic.

Formulating the investment decisions at least the investors should be able to understand and compare the trading value of the share and the value it should be. If they can understand this gap they will not expose to higher risk levels in the long run.

The investor should have the basic knowledge to calculate the net asset value per share and compare with market value. This will indicate the investor whether to invest or not while thinking about the future potential of the company.

Q. There are several cases having this nature of two different value scenario. What do you recommend?

A. As I recommended earlier, before the investor takes an informed decision basic analysis similar to earlier case should be conducted. You should consult your broker for a second opinion. At the initial stages of one's investor life the investor finds it difficult to do all these things. But, in the long run, like in other industries, there is no option other than systematic education. Though it was lacking in the past, now investors have the opportunity to select and study about investments.

Q. In your view who owns the majority of the portfolio?

A. It is an interesting question. According to the recent analysis done by the SEC based on CSE data, more than 85 percent of the portfolio value less than Rs 500,000 of retail investors in the CSE own only less than one percent of the total portfolio value and only about 0.5 percent of CSE investors are having greater than 100 million portfolio and they own 90 percent of the total value. This is the kind of ownership concentration.

This shows that there is a big room for retail investors to participate in the investments in the CSE. Thereby, one percent of the total investor population participating in the CSE can be enhanced gradually to reach four to five percent within the next four to five years if we deploy systematic programs to attract them to the market.

Q. Has the CSE become a gambling spot or short money provider? What is the role of the regulatory agencies in this regard?

A. The regulator can utilize the existing regulatory framework in order to address such issues. However, in any market misbehaviour cannot be fully stopped only through regulations. Most importantly it is the ethics of the market participants. The share market does not belong to one person. As we discussed, more investors will participate in trading activities in time to come, but their retention will be ensured based on trust. It can be established only through ethical behaviour of market participants, especially investors and brokers.

The other factor is awareness and education regarding investment decisions. You should know what you are doing. Every bit of behaviour of an individual in the market is not harmful to the market. This is why we always emphasise on the importantance of education and training. It is not rocket science and the only thing that an investor needs to do is to allocate some time to understand the basics of investment. This is an investment for your investment life.

Q. People are talking about manipulation in the market. What are your comments?

A. In any market not only in Sri Lanka some people try to manipulate the market and try to earn more at the expense of others. As per regulations it is an offence which should not be permitted. What I can say is though some try to attempt manipulation in order to reach their dishonest goals. If the innocent investor is adequately educated then one can escape from the burden of manipulation done by a few. Then the rest of the things are with the regulator in order to find out a proper solution.

For example, if a share is rising at an increasing rate any average person can understand whether the reaching price levels are reasonable or worthwhile. As I mentioned earlier, if it is few times of the net asset per share (or similar valuation method), then the value alarms the investor to think twice and move away from that stock to consider another stock.

If the followers also tend to contribute towards the rising pattern at any given time, people who manipulate the share will dump it on innocent people. This is similar to where an egg is priced at Rs 2,500 there will be no takers. However, the egg market is different from the finance market.

Every one in the market should not allow room for manipulation since it disturbs the efficiency of the market. First of all there must be a market for the investors to invest, brokers to facilitate transactions, regulators to regulate and media to report.

Q. What are the consequences of market manipulation?

A. This is what everyone should understand. It has a diverse impact. Public confidence (trust) in a fair and orderly market, one that reflects the forces of genuine demand and supply, enhances its liquidity and efficiency. Improper behaviour which gives a false or misleading impression of trading activity, price movements or market information leads to a reduction in market efficiency and confidence.

Every market is trying to ensure that its markets are fair, orderly and free of manipulative trading. In general, market manipulation involves intentional interference with the free forces of demand and supply to deceive or defraud investors, or for some other ulterior purpose.

When the natural balance is disturbed, I think firstly the people those who have invested in the long-run based on fundamentals especially the foreign investors might leave the market since they don't want to damage their wealth.

When the prices are high and rocketed due to manipulation, the people those who are having such shares would suffer a significant loss subsequently.

This may even lead to a market crash at the end since people can't trust. Therefore every person must play a genuine role to take necessary action against market manipulation.

Trading members and brokers may not always know if a client has a particular interest in a share or what it may be. However, a trading member or broker needs to be able to show that, taking into account the circumstances of the order, it should not have reasonably suspected that the purpose of the trading was to create a false or misleading appearance, or false market.

It is important that a trading member or broker who receives an unusual order is able to establish that he has made due enquiries and is satisfied as to the reason for the trading.

Capital market education can do a lot to provide overall understanding about how to behave in the market. When looking at some of the latest patterns, I feel that some participants ignore the rules of the game.

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