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Addressing structural weakness for Bursa’s underperformance

Asia Analytica
Asia Analytica1/15/2021 06:31 AM GMT+08  • 11 min read
Addressing structural weakness for Bursa’s underperformance
It is likely that political uncertainty in Malaysia is keeping many foreign investors away.
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Global stocks are off to a roaring start in 2021. Readers of this column would notice that we have been bullish on the global economy and stocks over the past few months. And we have laid out in detail our reasons in past issues.

Noticeably, Asian markets are outperforming Wall Street. For instance, the bellwether index in South Korea is up 9.6%, two weeks into the new year, while indices in Indonesia, Taiwan and Singapore are up between 5.4% and 7.5%. By comparison, the Standard & Poor’s 500 index has gained 1.4% while the Dow Jones Industrial Average is up 1.5%, so far in the year-to-date.

Again, we have already written a fair bit explaining why we think emerging markets will perform better than US stocks this year. This is based on expectations of weakness in the US dollar and increased appetite for risks, as fears and uncertainties related to the Covid-19 pandemic recede with progressive immunisation of the world’s population.

In particular, Asian GDP growth is expected to outpace the economic recovery in major developed countries. China already has a substantial head start in this respect, given its early and successful containment of the outbreak. The strength of its recovery will spill over into the region, where it is the dominant trading partner.

While stocks on the Bursa Malaysia too started 2021 on a positive footing, the FBM KLCI is underperforming regional markets. The benchmark index is up just about 0.5% for the year-to-date.

Selling by foreign funds continues to weigh on local stocks, especially for large, FBM KLCI heavyweights. Foreign investors pulled RM337 million from the Bursa in the first trading week of the year. By contrast, South Korea and Taiwan reported huge foreign fund inflows over the same period, which underpinned their robust market gains.

It is likely that political uncertainty in Malaysia is keeping many foreign investors away. That said, foreign investors have been net sellers for far longer, in six of the last seven years. We explored this subject in depth in September last year. In fact, Malaysia lost its attraction to foreign equity investors after the Asian financial crisis in 1998/99. The use of capital controls caused permanent damage.

Aside from steadily declining profitability for many local-listed companies — owing to deep-seated structural issues such as chronic underinvestment in productive assets, technology, R&D as well as over-reliance on low-skill foreign labour and failure to move up the value chain — Malaysia as an investment destination is also being increasingly marginalised as a result of the rise of China and, to a lesser extent, India and other newly emerging countries such as Vietnam. There is a lot more competition for foreign investment dollars — and Malaysia has not been competing effectively, for all the reasons we have just mentioned.

In addition, the reality is that fund managers are assessed based on their quarterly performances. Stocks that do not perform in the short term will be sold, regardless of underlying fundamentals.

It is telling that while our Malaysian Portfolio has outperformed the benchmark index since its inception in October 2014 — up 92.3% even as the FBM KLCI dropped 10.6% — much of the gains were front-loaded. This is a key reason that we started the Global Portfolio, in December 2017, a tacit acknowledgement that domestic stocks will underperform.

Total returns for the Global Portfolio now stand at 53% since inception. Over this same period, the Malaysian Portfolio has gained just 11.5% — despite our obvious comparative advantage in terms of knowledge and familiarity with local stocks. Incidentally, the FBM KLCI fell 6.6% during this period.

We think the lacklustre performance of FBM KLCI, the benchmark index, is also diminishing the attractiveness of Bursa as a listing destination for big, quality and growth companies, and especially for innovative, tech companies.

Case in point, over the last five years, there have been only 41 IPOs on the Main Board, of which only three have prevailing market caps above RM10 billion — Sime Darby Plantation, Press Metal Aluminium Holdings and Mr DIY Group (M) — and 11 with market caps above RM1 billion. When was the last time you were truly excited over an IPO?

It does not bode well for the domestic capital market if local companies cannot raise funds at valuations they deserve and investors are investing abroad for higher returns and better choices of quality companies. This is a pressing issue that needs to be addressed.

Undeniably, foreign investors have a big influence on the market’s performance, and especially on the FBM KLCI. The 30 component stocks account for 62% of total market capitalisation of the 936 stocks listed on Bursa. In contrast, the Dow Jones Industrial 30 stocks account for only some 20% of total market cap for all companies listed on the New York Stock Exchange. Clearly, Bursa lacks depth and width. Too many companies listed are too small and insignificant.

Chart 1 shows the correlation between annual foreign fund flows and the FBM KLCI — the index generally rises in the years where there are net inflows and falls when foreign funds are net sellers in the market.

We cannot be sure when, or even whether, foreign investors will return to the country. What this means is that Malaysia can no longer take the inflows of foreign money — be it in terms of foreign direct investment or the capital markets — for granted or rely on them to drive growth.

Future policies should, therefore, focus on better application of domestic savings. We must be the captains of our own ship! We certainly must be the catalyst to chart the course of our own future.

The Employees Provident Fund (EPF) controls one of the biggest pools of domestic savings — investment assets totalling some RM942 billion as at end-September 2020. The EPF has been aggressively diverting its money overseas, however, instead of investing domestically.

Case in point: Since 2010, its overseas investments have increased seven times — from about RM43 billion in 2010 to over RM300 billion last year. By comparison, total investment assets have only slightly more than doubled while the total value of its holdings in Bursa have increased only 1.9 times. Overseas investments rose from under 10% of total investment assets in 2010 to 32% in 2020.

We understand that the EPF wants to diversify its investments and maximise returns for contributors and we applaud its past performance. As the sole custodian of compulsory savings and retirement planning for all Malaysian workers in the private sector, however, should it not also have a duty to promote growth and wealth creation within the country?

And it is timely, given that global interest rates have bottomed — being at literally zero — and, with synchronised global growth, a rise in rates will cause the EPF’s holdings of foreign bonds to make losses. And with our argument that the US dollar is on a secular decline, the negative impact on the EPF will be even larger.

Charts 2 and 3 track the annual value changes for foreign and EPF shareholdings on the local bourse as well as share margin financing against total market cap change for the past 10 years. As mentioned above, foreign funds have outsized influence on the local stock market. Critically, a relatively small amount of funds has magnified impact in terms of changes in total market cap.

For example, in 2020 (up to October, as this is the latest data available for share margin financing), net foreign funds outflows of RM23 billion — or just about 1.4% of Bursa’s total market cap of RM1.6 trillion — resulted in a total market cap drop of nearly RM90 billion. In 2017, net foreign funds inflows of just RM10.8 billion contributed to some RM240 billion in total market cap gains. The FBM KLCI ended 9.4% higher that year, the biggest advance since 2013.

The point is, it does not take a lot to move the market — and create a multi-fold wealth effect for all shareholders. Company valuations are based on marginal change in stock prices. This theoretical construct does pose certain questions but that is a discussion for a Noble Prize paper. Let us say the EPF repatriates half of its existing overseas investments over the next five years, totalling RM150 billion, or about RM30 billion annually.

Imagine if this amount is then split equally between domestic bonds and stocks. That means about RM15 billion of fresh money for Bursa annually. It would more than offset recent years of annual foreign outflows, on average, and potentially generate as big a positive impact on the market, as foreign funds did in 2017. In fact, the mere articulation of this strategy or intention would suffice to help valuations on Bursa and attract both foreign and domestic capital inflows.

While the performance of big caps has been lacklustre, the same cannot be said of smaller-cap stocks, which did exceedingly well in 2020 — driven primarily by retail investors. Daily trade volumes on Bursa surged to 7.6 billion shares, on average, in 2020 — up from 2.68 billion shares in 2019.

We saw companies hitching onto the glove manufacturing and, later, vaccine distribution bandwagons — announcements that sent their stock prices sharply higher.

The FBM ACE index more than doubled, compared with the 2.4% gain for the FBM KLCI and 3.9% gain for the FBM Emas index. The total market cap for ACE-listed stocks grew from RM16.7 billion at the start of 2020 to nearly RM39 billion as at Jan 7, 2021. The 10 largest capitalised ACE stocks account for about half of this total market value and are currently priced at an eye-popping 103 times their combined trailing 12-month (TTM) profits — some are not even profitable — and more than 12 times TTM sales and book values.

It would not be an overstatement to say most of these stocks are in a speculative-driven bubble. Margin financing is on the rise and many are buying these stocks with a gambling mentality (see Chart 4).

This is a dangerous sign. All bubbles burst. While every investor may think they can get out before this happens, many will be left holding the baby when the music stops. Regulators need to act now, to prevent the eventual pain, especially for novice investors, which might also set the market back years. As they say, once bitten, twice shy. The most efficient way would be to require upfront cash deposits before any purchase of shares listed on the ACE market.

To summarise, there is no question that Bursa has underperformed in recent years, the 2020 speculation-driven penny stock euphoria aside. The question is how do we reverse this trend?

Clearly, Malaysia needs to break the vicious cycle where chronic underperformance of the Bursa leads to its inability to attract quality, growth companies to list and invest-operate in the country, which then leads right back to where the market cannot attract funds and, therefore, continues to underperform.

In this respect, we believe the EPF — and large government-controlled funds such as Khazanah Nasional — must take on the critical role of repatriating money currently invested overseas to invest domestically.

The infusion of fresh funds would kickstart a new virtuous cycle, where an outperforming and vibrant capital market will attract quality listings and make Bursa the preferred destination for domestic fundraising and investments.

At the same time, Malaysia needs to undertake tough structural reforms to address the issues of weak earnings growth, declining profitability and underinvestment by the listed companies as well as rampant rent-seeking. The prospect of growth and rising stock prices will then attract more funds into the country and, in turn, more investments and so on.

The Global Portfolio fared better than the benchmark index in the week ended Jan 14, gaining 2.7% and lifting total returns to 53% since inception. This portfolio is outperforming the MSCI World Net Return index, which is up 37.7% over the same period.

Notable gainers last week include China-based automaker Geely Automobile Holdings (+18.0%), Okta (+7.0%) and Qualcomm (+4.1%). On the other hand, Builders FirstSource (-5.7%), Ericsson (-3.4%) and Walt Disney Co (-1.7%) were among the bigger losers.

Disclaimer: This is a personal portfolio for information purposes only and does not constitute a recommendation or solicitation or expression of views to influence readers to buy/sell stocks, including the particular stocks mentioned herein. It does not take into account an individual investor’s particular financial situation, investment objectives, investment horizon, risk profile and/or risk preference. Our shareholders, directors and employees may have positions in or may be materially interested in any of the stocks. We may also have or have had dealings with or may provide or have provided content services to the companies mentioned in the reports.

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