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Investors' risk tolerance level

A neglected issue in Bangladesh

Jasim Uddin Haroon | November 23, 2020 00:00:00

Bangladesh has now approximately 2.4 million active Beneficiary Owner (BO) accounts holders managed by the securities depository -- Central Depository Bangladesh Limited (CDBL). The BO account holders are allowed to trade on the exchanges and apply for subscription of IPOs. They represent all strata of the society. They include highly educated people, a limited income group of people, small vendors, housewives, pensioners, and even illiterate people. In any society, the financial strength of all people is not equal. Some people belong to the high income group while some to the limited income group. And risk tolerance level of all the people is also not the same. Some people are usually prone to taking risks while some avoid the same. The issue of risk, in fact, varies from person to person and even institutions to institutions.

Risk tolerance is the degree of variability in investment returns that an investor is willing to withstand in their financial planning. Those with a higher net worth and more disposable income can also typically afford to take greater risks with their investments. This is very much important for capital markets --- advanced, emerging or frontier economies.

Such matters are very much important for Bangladesh where the market is dominated by equities, not a mix of equity and bond or derivatives. Ideally, investors face a test before their investment decision. Even to robotic financial analysts, such tolerance is also visible. Such risk tests called IPS by portfolio managers and market analysts suggest investors where they actually invest--- fixed income or equity market. By definition, an IPS is a written document that clearly sets out a client's return objectives and risk tolerance over that client's relevant time horizon, along with applicable constraints such as liquidity needs, tax considerations, regulatory requirements, and unique circumstances. However, the IPS provides the foundation of the portfolio management process. In creating an IPS, the manager writes down the client's special characteristics and needs.

If someone is found to have an aggressive tolerance category they are usually advised to invest in equities mostly while a tiny part in fixed income instruments and vice versa.

The best practice is that the portfolio managers conduct a quick IPS [investment policy statement] on the investors at a time when they first express their intention for investing money in the capital market. The provident fund and pension fund are believed to be an ideal area for investment for risk avoiders. But Bangladesh lacks such types of funds traded on the bourses. But, there are a number of fixed income instruments in the financial market, they are FDR, investment in government sanchayapatra, and even another risk-free instrument T bill and bonds.

IPS designed in such a way that after conducting a successful IPS test with proper process helps the portfolio managers make proper investment strategy for the investors.

Legal aspect: Even in Bangladesh, there is a provision in the merchant banker and portfolio manager rules -1996 pertaining to conducting of such stress tests for the potential investors.

This author however visited five leading merchant banks located in Dhaka to know the status of the IPS. The main objective of the study was to analyze the status of the IPS in our capital market. However, the other specific objectives of the study were: To assess the mean number clients involving with the merchant banks, to analyse the education level of the investors with the merchant banks, to assess the mean investment size of the clients, to understand the size of the analysts and their educational background; and put forward some recommendations.

The merchants where the author visited are: EBL Investment Limited (EBILL), MTB CAP, Lanka Bangla Investment, IDLC Investments and AAA Investment and Finance. During the interviews through a written questionnaire to top CEOs and portfolio managers, it was evident that none conduct such risk tolerance tests on the investors before investment. Even many not are aware of the matter.

Bangladesh has some 60 merchant bankers and they all have separate departments to handle the discretionary and non-discretionary accounts as per the rules concerned. On the average 1000 clients belong to the both discretionary and non-discretionary accounts being maintained with the merchant banks. But interestingly, most of the portfolio managers do to maintain the preorder process while handling the investment plan on behalf of the investors.

The issue of the IPS is very important as the BSEC and other quasi regulators have been promoting financial literacy. Such tests will help take proper initiative to introduce or implement proper planning while handling discretionary/non discretionary accounts.

It is found that the institutions all have portfolio managers. But the number of analysts in the merchant banks is not large, the mean employee in the department is 03 (three). They maintain both discretionary and non-discretionary accounts as per the Merchant Bankers Rules and Portfolio Manager-1996.

The number of discretionary accounts is also not large. The mean number is 200. On the other hand, the number of non-discretionary accounts is comparatively higher than that of the discretionary accounts which is also a matter of concern in the absence of IPS. The avenge size of clients with the top merchant banks is 1000. And the investment size is Tk 100,000.

The education background of the analysts has a mix -- different disciplines but they are some portfolio managers who have direct knowledge on the finance and capital market, found two qualified CFAs (Chartered Financial Analysts) working as CEO of the merchant bank.

They all believe that the BSEC should take initiative to efficiently implement and monitor the IPS test for the interest of the investors and the market.

Bangladesh's market had faced two major debacles, one in 1996 and another in 2010. But the education level both from the institutions and the investors largely remained neglected. Such best practice while handling the investors is of critical importance. The following recommendations and suggestions may be considered.

Strict maintenance of the IPS by the portfolio manager and follow up should be ensured by the regulator. Proper education and training of the analysts should be ensured. BSEC should monitor and ensure as to whether the analysts are counseling the investors or not. BSEC approved app-based or digital platform with the clients may be introduced as the securities regulator is in favour of digitalisation.


The author is a Special Correspondent of the FE. He can be reached at

[email protected]

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