Why people don’t invest in PSX, and why you should?

I will start this piece by quoting two people who are considered authorities on investments. The first is a respected economist and Nobel laureate Paul Samuelson: “Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas.” The second is Warren Buffet, one of the most successful investors in the world with a net worth north of 86.3 billion US dollars who has said, “The most important quality for an investor is temperament, not intellect.”

Put together, what these gentlemen are essentially saying is that investment is not how well you can predict the market or how smart you are in evaluating which way investment winds will blow, rather it is about being patient, tranquil, and careful, and giving your investments time.

For the purpose of this article, we will discuss investments in the context of our local stock market – the Pakistan Stock Exchange (PSX).

The Pakistan Tehreek-e-Insaf is attempting to improve Pakistan’s local investment culture and is trying to bring people into the fold of savings and investments. Finance Minister Asad Umar was correct in his statement at the launch of the Medium Term Economic Framework (MTEF) that the savings rate in Pakistan is lower than most similar economies. In 2017-18, private sector saving amounted to about 12.2% of GDP of which 1.4% was preempted by the government to finance its consumption, said the MTEF document.

An overall savings rate of 10.8% of GDP (in 2017-18) is still only half the savings rate achieved by Pakistan in 2002-03, and about one-third of the savings ratio in neighboring India, where it is 34% of GDP). The MTEF plan itself includes the promise that PSX will offer new products such as voluntary pension funds and explore distribution channels to bring in retail investors to at least one million. In the proposed amendment bill announced by Umar in January, carry-over of capital loss in stock trading was also allowed for three years.

At the same time, there is a shocking dearth of any awareness-raising campaigns by the government, or any entity including the PSX itself, to educate potential investors on various avenues of investment. The only such example that can be found are sessions held by the PSX at chambers of commerce and industry in various cities.

Profit spoke to about three dozen business students at the Institute of Business Administration in Karachi (IBA) and the Lahore School of Economics (LSE) in Lahore, as well as some investors, to learn about their views on why the general public does not invest in the Pakistani stock market. The most common replies can be classified into three categories:

  1.     A lack of awareness about how to invest in the PSX and low levels of trust in stock traders
  2.     The stock market is not considered “safe” to put one’s money in so they’d rather invest in real estate or gold, and
  3.     There is no place for small investors in the stock market as it is manipulated at the highest level and is a playground only for the rich.

This article will attempt to address all three concerns, in addition to providing some guidance for younger and/or newer investors on how to avail this investment opportunity while avoiding the most common pitfalls. Some knowledge of terms like deposits, dividends, risk appetite, margins etc. is expected but if you’d like to look up these definitions, Investopedia is a great place to start.

Lack of awareness and trust in stock brokers

There is no denying the fact that Pakistan does not have many free or formal channels where interested individuals can study and explore the stock market as an investment option, and the ones that exist need to be marketed aggressively and covered properly in the media.

“The maximum investment news is a one-liner about the direction that the stock market took for the day,” says Syed Zafar Abbas, general manager at Zahid Latif Khan Securities (Pvt.) Ltd. “How, then, can we hope that the public will develop any interest [in investing]?”

A perfect example of the situation is the rare website “JamaPunji”. Launched and managed by the Securities and Exchange Commission of Pakistan (SECP), the website includes a stock trading simulator and explains the different types of investments that can be made in the stock market. When asked if they were aware of this platform’s existence, surprisingly – or perhaps not – none of the students or the investors who spoke to Profit said yes. The only group that knew of the platform were people who are already traders.

So how do people who invest do it? Let’s take inspiration from two people who have invested in the PSX.

Mansoor Ahmed, a graduate of LSE, said that although his motivation to invest in the stock market came from his business education, his first helper was the website investorguide360, where financial analysts write blogs on investments and provide guidance on the stock market. “I started to read different articles and if I found several people talking about the same stock, I would go online and check that stock myself before investing in it,” he said.

His infatuation with the PSX began in 2014 and since then, discounting the dividends that he has earned, he has made an unrealized loss of about 30%; unrealized because he has not sold his investments at a price lower than at which he bought them. Rather, he is holding on to them and waiting for their recovery. However, since he did not opt for margin financing, he has the ability to hold on to his investment while it recovers. (More on margin financing later).

Another investor Jahanzeb Tahir, a Masters degree student at IBA, became interested in the stock market because his sports mates are investors who introduced him to this channel as a means of additional earnings. “My first experience and learning came from my friends with whom I play tennis. They have been dabbling with stocks for a while now and they taught me the basics but choosing stocks is something I learned on my own,” he explained. “There are some companies that you can simply tell are doing well by their financial statements; others you see through the news and analyst reports.”

He has also undergone the same experience with his stocks as Ahmed but is happier with his dividends. “I made an unrealized gain of approximately 12% on my capital investments when the market was up, and now I am down by 15%. But I have not sold my stocks so I can say that so far I have earned well in dividends.”

Both these investors said that they did not feel the need to go to a stock brokers to start trading. There are some legal requirements involved, such as opening an account with a securities company that is registered as a brokerage house with the stock exchange. A certain %age, also known as a “commission”, goes to these individual brokers with every sale and purchase of a stock. But beyond that neither of these two investors said they needed day-to-day guidance on which stock to sell or buy.

The bottomline is that it is not necessary for an investor to trust a certain broker. There is a plethora of information available in the form of trader reports, analyst reports, and there is also the stock exchange website which shows real time movement of stocks. As far as a lack of awareness is concerned, for now it is up to the interested investors to look for information on their own until the authorities and regulators realize their responsibility to provide easy access to such information on a much wider scale than is being currently done.

Real estate or gold is a safer investment

Pakistan’s economy is volatile. That much is a given. But Pakistan’s stock market is even more volatile. That also is a given. But that in itself does not make this type of investment “unsafe”. As was mentioned in the very beginning, it is the investor’s temperament that makes stock investments safe or unsafe.

“The younger lot often comes in with the idea, or at least the initial goal, of doubling or tripling their principle investment overnight. Therefore, many choose to go for speculative trading or leverage products,” said Muhammad Irfan, CEO of Askari Securities Ltd. “This is the primary reason why smaller investors quickly get squeezed out during market troughs. This is also why overly passionate investors enter the stock market, suffer losses, and then bid farewell to stocks forever losing out on so many potential opportunities.”

Let’s discuss speculative trading first. Speculative trading, also called margin financing or speculative stocks, is defined by Investopedia as “stocks with a high degree of risk. Many traders are drawn to speculative stocks due to their higher volatility … which creates an opportunity to generate greater returns (albeit at a greater risk). Most long-term investors and institutional investors stay away from speculative stocks…”.

Speculation itself in the stock market is defined as “the act of conducting a financial transaction that has substantial risk of losing value but also holds the expectation of a significant gain or other major value.” In other words, you either lose big or win big. Coming back to the PSX, this is where many new or tentative investors lose their money and then walk away from trading on the stock market altogether.

Irfan defines another practice that falls within the ambit of margin financing: where an investor can trade on more than their invested capital. Consider this example: you have already invested Rs.100,000 but, through margin financing, you take on three or four times the liability of the invested amount – say Rs.400,000 – and trade on that. You will pay interest on this additional amount at KIBOR + 8%, compounded daily. This means that if your “speculation” is correct, the returns you will make on this investment will far exceed the commission and interest paid on the extra amount. But at the same time, if your expectations of the market goes wrong, the loss is equally massive. (KIBOR stands for Karachi Inter Bank Offer Rate)

“If you are trading at just as much as you have invested, then even if the market goes down, you have the chance to wait for the market to recover. However, if you have chosen margin financing, then you don’t have that cushion,” explained Irfan. “The losses made per day as a result of such speculation are deducted every day from the investor’s account with the stock exchange, until her or his actual invested amount is reduced to thirty% of the original amount.”

Another reason why the stock market is seen as “unsafe” is the mistaken belief that one needs to continuously keep trading to make money. “If we advise investors to hold on to their investments, they push back saying that the market is showing an upward movement and we are not capitalising on that,” said a stock broker on condition of anonymity as he was not authorized to speak to the media. “They accuse us of being lazy for not indulging in trading every day. But, if we do trade their stocks as they ask, then more often than not they end up losing some money and again blame us.”

The third piece is the perceived insecurity of stocks compared to returns through investing in gold or real estate. Investors who choose to buy gold or plots of land do not intend to sell their investments the next day or even the next week of the purchase. Why, then, is the stock market considered any different? If investments in the stock market are also treated as long term affairs, rather than indulging in speculative investing, the risks associated with it can be mitigated.

PSX is not for small investors and manipulation at the higher level

The first part of this argument is incorrect, but there is some merit to the second. Let’s begin with the first half.

At Zahid Latif Khan Securities, the minimum investment amount is Rs.50,000 and this amount is fairly standard at most other companies; it may vary but only slightly. If a share’s price is less than Rs.100 per share, then an investor needs to buy at least one hundred units in order to make their investment worthwhile i.e. a maximum of Rs.10,000. With Rs.50,000, they can buy as many as 500 shares! For shares priced at higher than Rs.100, bundles vary and investors can buy more or less than 100 shares.

Now compare this with gold. As of April 12, 2019, the price for one tola of gold – the minimum amount at which investing in gold would make sense – is Rs.70,700. Seeing these numbers, you can easily conclude that the stock market very much has space for smaller investors and is definitely an avenue that they should consider.

The second half of this argument, however, is a very contentious issues – insider trading and stock price manipulation, a problem that is not exclusive to the Pakistani stock market but is a part and parcel of investing in any stock market in the world. One way to avoid getting mired in a sticky situation like this is to steer clear of investments offered by securities companies themselves which may create a conflict of interest for brokers.

One of the most common methods of price manipulation is to artificially increase the price of a stock if it is in the interest of an investor to sell it. One way to do it is to create a hype in favor of the stock (thereby increasing its demand) and then simply letting the market forces of demand and supply take effect. The conflict of interest arises when stock brokers have a stake in the stock themselves and are also responsible to advise individual investors on their choice of stocks for trading on any particular day. This not only perpetuates a lack of trust in brokers but can also lead to massive losses for naïve investors who succumb to such hype.

Even if stock brokerage houses do not invest themselves, artificial hype can still be created by investors who hold massive amounts of stocks of any kind, value, and denomination. This is where market risk and uncertainty become an unavoidable part of trading in stocks. However, with a little bit of patience, some market research, and an entrepreneurial spirit, individual investors can reap the benefits of participating in the stock market.

The beginner’s guide to investing

So where should novices begin? They should seek out asset management companies (AMCs). Investopedia defines these companies as “a firm that invests pooled funds from clients, putting the capital to work different investments including stocks, bonds, real estate, master limited partnerships, and more. Along with high-net-worth individual portfolios, AMCs manage hedge funds and pension plans, and – to better serve smaller investors – create pooled structures such as mutual funds, index funds, or exchange-traded funds (ETFs), which they can manage in a single centralized portfolio.”

The basic factor at play here is that because AMCs bring together several investors, leading to a higher sum total of investment, they can provide smaller investors an opportunity to work with bigger, better, and more expensive stocks. They utilize economies of scale on their end and individual investors get higher returns proportionally through AMC-offered funds when compared to wholly as individual investors. Through this medium, the minimum capital requirement (of Rs.50,000) can also be avoided and the risk can also be mitigated because investments are made into diversified stocks instead of one or two companies. The companies are also responsible for choosing, buying, and selling stocks so a new investor also has more cushion to learn about trading before going solo into the world of the stock market.

Final word

In conclusion, those who have less familiarity and knowledge of the stock market should go with asset management companies. However, those who do have basic financial knowledge may choose to invest directly but it is highly recommended that you choose long-term investments. Those who are confident that they are very proficient in how stocks work may choose margin trading and if you are one of those who consider themselves to be ahead of the curve in PSX knowledge, you could even delve into derivatives!

Novices, hold on. This is not the time for you to know what “derivatives” are. That is for another time and another article. Good luck!

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