Overcoming the greed and fear factors

'Beyond Greed and Fear' is a popular book written by Mr Hersh Shefrin. The book is focused on understanding behavioural pattern of finance and the psychology of investing. Mr Shefrin in his book said: "Even the best Wall Street investors make mistakes. No matter how savvy or experienced, all financial practitioners eventually let bias, overconfidence and emotion cloud their judgment and misguide their actions. Yet most financial decision-making models fail to factor in these fundamentals of human nature." That attests to how crucial the behavioural finance is, when it comes to investment in the stock market.
It is far more important for the stock market in Bangladesh as far as we aspire for its sustainable development. But until and unless all the stakeholders including BSEC (Bangladesh Securities and Exchange Commission), stock exchanges, policy makers, stock market practitioners, small investors and other major stakeholders work in a collusion-free environment, sustainable development of the market is not possible. All the parties should work without any fear or greed for its sustainable development. At the time of framing policies and regulations also the parties concerned should do their jobs without any fear or greed keeping in mind the nature of the stock market here and shape up their policies as required.
There is a saying: "No risk, no gain." This is more relevant to investments in stock markets. It cannot happen that any investment in the stock market will not involve any amount of risks. When on one side of the coin is the gain, on its other side is the risk. Sometimes the risk involved in share trading hits its zenith sending share prices into free fall. Experts call it a market crash. The crash happens promptly and devastatingly, faster than the time the market takes to reach a certain level of progression. During such a crisis period the investors feel their money is at risk and therefore they sell out their holdings quickly. Other institutional investors also react immediately triggering a wave of panic throughout the financial sector. When the crisis is over, the investors, on the other hand, often become very choosy about making new investments, even though everybody admits that this is, in fact, the right time to re?invest. Thus the crisis lingers on.
A post-market crash period is very important, because during that time any invisible crash, though on a small scale, can happen. Those, who are involved in the share market, lose their confidence to a great extent. Thus there arises the confidence crisis, which is also one type of crash that makes the market unstable.
The stock market in Bangladesh is a frontier market in nature. It is easy to derive any undue benefit from such a small market by manipulating things. So, what we need is to rise above greed and fear and let the market function as per its fundamentals.
If the stock market, especially the Dhaka Stock Exchange (DSE), is compared with international markets in terms of their main price index, PE ratio, market capitalisation, total trading value and market capitalisation-to-GDP ratio, we see more fluctuations in the DSE indicators than those in the overseas markets. During the period from 2009 to 2012 extreme fluctuations happened. This happens because of the market's deviation from fundamentals and manipulation.
The stock market will not be stable, if the sectors involved with it are not stable. So, much depends on sustainability of the related sectors like mutual funds, insurance companies, merchant banks, bond markets, banks etc in the overall financial sector. Many think the stock market crashes in 1996 and 2010-11 happened mainly due to the structural weaknesses. So, effective financial safeguards like corporate governance, adoption of an international financial reporting standard and a special tribunal for the market should be made effective as early as possible. There also should be a technical setup to analyse the causes of a market crash.
In Bangladesh most of the stock market investors are small investors and their knowledge about investments in the share market is not up to the mark. So, if the regulators of the capital market ensure proper safeguards inside the share market, then it will be better not only for the institutional investors, but also for the small investors.
The stock market in Bangladesh is still deemed a frontier market in the global perspective. It is a long way to go before we attain the international standard. Some recommendations have been made here, which will help develop the stock market on a sustainable basis.
The recommendations are as follows:                           
Making BSEC truly independent: The BSEC should work independently without any interference of the government, the big players and other authorities involved with the market. A discipline committee can be constituted comprising experts from international financial market consultancy firms and the BSEC, chartered accountants, financial analysts and planners. If the committee cannot hammer out an amicable solution to a problem, then the BSEC will act to have a significant impact on the stock market as a supreme authority. In addition, the BSEC should focus on the forward-looking steps, as follows-
(a)    Firstly, the BSEC should come forward showing zero tolerance while dealing with the listing procedure, proper IPO pricing, satisfactory financial disclosure, market surveillance and monitoring.
(b)    Secondly, the BSEC has to earn credibility.
(c)    Thirdly, the BSEC has to come forward with necessary action against those institutions that fail to implement the Bangladesh Fund, the Market Stabilisation Fund and ensure further bank investments and so on.
(d)    Fourthly, the BSEC must be cautious that neither of its members nor any of its officials is involved either directly or indirectly with the transactions in the stock market.
(e)     Next, the BSEC should hire certified Chartered Accountants from both inside and outside the country to ensure the cent percent accuracy of the financial statements of listed companies.
(f)     Finally, the BSEC should set up its own media wing, when they are meeting with other market authorities regarding policy making.
Future plan of the DSE as a major bourse: The DSE can play a vital role by implementing the following forward looking plan:
(a)    The DSE must ensure flawless monitoring of the brokerage houses and at the same time take safeguard measures against forced selling or any type of irregularities.
(b)    The DSE should be cautious about making any comment that does harm to the market environment.
(c)    The DSE should look forward to taking educational programme on a regular basis and with the support of the BSEC and the Ministry of Finance (MoF) should start educational programmes for investors at the grassroots level.
Confirming admirable support from the government's side: The government -- here the Ministry of Finance (MoF) -- should work in such a manner that people or small investors cannot blame the government ever. The Ministry of Finance should open a legal and advisory cell regarding the capital market. The one and only task of this cell is to observe the daily trading session in the stock market along with the SEC and provide strategic support. At the same time it will also ensure that their advisory role should not create any conflict of interest with regard to the primary task of maintaining discipline in the capital market. A legal and advisory cell can be made with 5 to 7 members including one team leader and one financial market lawyer. This cell will build a bridge between Bangladesh Securities and Exchange Commission and the Ministry of Finance.
Prolonging financial discipline for balancing the money market and the capital market: The first and foremost thing is that the Bangladesh Bank (BB) should ensure sustainability of a sound banking system inside the money market. In addition, the BB can also set up a supervisory cell for dealing with financial discipline in the money market and strengthening its coordination with the stock market. The main task of the cell is to take paramount legal steps against dishonest merchant banks which were involved in illegal activities in addition to monitoring financial institutions' direct and indirect exposure to the stock market. Moreover, the cell will also serve as an intelligence platform between the BSEC and the Bangladesh Bank.
Establishing a vibrant software-surveillance system inside the market: After the stock market crash in 2010-11 the concerned probe committee analysed a number of fraudulent activities inside the stock market. Those are also known as market anomalies. The fraudulent activities include: a) direct listing of companies in the IPO stage; b) revaluation of companies' shares; c) fixation of share value at a high level; d) Misuse of the book building system; e) Making illegal placement of shares in favour of selected persons or companies, in which issuers, issue?managers, valuers, auditors, dealers and brokers were involved; f) involvement of dealers, brokers and investors in the secondary market operations of circular trading, block trading and unexpected transactions. Every type of manipulation, irregularities and speculation was possible in the small market that we have in Bangladesh. So it is urgent to set up international standard surveillance software with a view to identifying anomalies in transactions at different trading points.
Establishing a good media reporting system: Media plays a pro-active role regarding stock market issues. For instance, the print media, TVs and online media have left a significant impact on the market through reporting on market trends, dishing out market?related information and illustrating not only the present status of the market but also commenting on the future. At the same time it should be ensured that the news presented is neutral.
Drawing up a plan for development of capital market: A good shape of the capital market can be given through legitimate participation of institutional buyers (Mutual Funds, Merchant Banks etc.). An appropriate mechanism to strike a balance between demand and supply might boost growth of the capital market. It is also important that during the crisis period they play a pro-active role. For instance, they should ensure a balance in the stock market by buying shares when there is a selling pressure and vice-versa. They also need to be committed to not making any forced sale. In addition, they should avoid all sorts of transactions through omnibus accounts that affect the market.
Demutualisation of the stock exchanges: Obviously demutualisation is a good step. The  separation  of  ownership  and  management  of  DSE/CSE  from  brokerage  houses  is required primarily to reduce the conflict of interest associated with the day?to?day operation at the stock exchanges. It is believed that demutualisation is an ultimate solution to spread of rumours, manipulation and fraudulent practices. But hopes should not be raised about instant advantages of it. The BSEC can play an active role in making the investors aware of the fact.
Developing financial safety-nets: The BSEC and other market regulators should develop an effective mechanism to stem any stock market crash. It may be sort of packages including better and strong corporate governance, an international financial reporting standard in the stock market, a special tribunal and legal framework against the cause of stock market deviation and so on.
Strengthening the market base: The fundamental base of the stock market needs to be stronger and broadened. Regardless of what is the logic of a stock market crash, individual investors are the ultimate victims. It also affects their socio-economic condition. So they should be cautious regarding investing in a stock market and always put emphasis on market fundamentals or key factors. For instance, they must analyse the company's crucial factors including EPS, P/E ratio, NAV, future growth, industry average etc.
Focus on financial credibility and transparency: Most of the listed companies are not staying in the process of maintaining cent percent financial credibility and transparency. It is the main obstacle to our share market. The regulatory authorities do not properly monitor the activities of listed companies.
Introducing new products in the share market: Everywhere in the world a certain portion of risk is involved in equity trading. Bangladesh is also not an exception. A lot of retail and institutional investors are vastly interested in equity trading. The lack of multiple products inside the share market forces them to go for excessive trading.  There is no system developed inside the market like the indication of high risk or low risk involved in any share issue. As a result, many investors blindly invest in the share market without knowing this thing.
In our market the corporate bond and preferred share are very important, when it comes to fixed income. So, the BSEC should introduce corporate bonds and derivatives as new products for strengthening the capital market.
Focus on corporate issues: Each and every bank in Bangladesh has established their own investment banking department for launching corporate issues.  They collect funds through the capital market for assisting various corporations in Bangladesh. In this case, there are so many groups of companies in Bangladesh and they are quite able to go for IPO/ primary market. If they are listed with the capital market, they can reduce the excessive dependence on one single sector and collect funds through share business.  As a result, a concrete/transparent corporate governance structure may be established inside the share market. In that case, profits of the family-based groups of companies will fairly be distributed among the small investors inside the share market.
Focus on long-term financing through share market: It is high time to convince all the stakeholders in the capital market that it is the best place for long-term investment. Already two big-bang crashes happened in our market. So, it is not wise to think that short-term gain or quick profit motive will work in this market.
Strategic reforms in financial market: To create an efficient, competitive and stable capital market by strengthening the legislative and institutional framework aimed at prudential regulation of the market, the focus should be on:
(a) Establishing harmony between money market and capital market:
    The government should pay attention to creating and sustaining a strong bank regulatory system to reduce excessive risk-taking in their share business. On the other hand, Bangladesh Securities and Exchange Commission should introduce tools that would mitigate the risk for investors. This could include a financial netting facility where investors buying any stock would have to wait for a certain period before they could sell the stock.
(b) Exposition for government intervention in capital market:
Government intervention in the capital market is important to ensure viability of the share market, promote economic efficiency and prevent panic and any crisis.
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The writer is a stock market analyst now serving at BRAC. He authored "Bangladesh Share Market: Looking ahead after two big crashes".
Email: toufique2010@gmail.com