It is generally accepted that there will be some risk involved in any market and in any investment. No one will guarantee 100 per cent risk-free environment for any market. However, there are some market fundamentals that are managed through regulated transactions and through institutional practices by which general preconditions for risk management and exit, and securities are protected. These are very fundamentals of market practices and only in operational level the vulnerability of market is revealed. Risk management at institutional level and with regulated control, therefore becomes unpredictable and can create low-key volatility.
It is generally assumed that that low risk means low return. While plenty of studies support this premise, it has been proven not to hold true in all circumstances. In particular, equity portfolios designed to reduce absolute risk can actually provide better returns than traditional, market-capitalisation-weighted stock indices over the long term. Amid the resurgence of significant market volatility, many investors wonder whether risk management techniques have evolved since September, 2008. The events which brought giants such as Lehman Brothers and AIG to their knees raised questions of whether a misunderstanding of risk and risk management practices was at least partially to blame. Some even pointed the finger at risk models which they believe failed to properly account for "black swan" events - rare, unexpected events which, in hindsight, would have been predictable, such as the mortgage meltdown.
Wylie Tollette, Franklin Templeton's SVP and Director of Performance Analysis and Investment Risk, says avoiding over-reliance on models is important to mitigating risk:
"Models are just another tool in an investor's arsenal. I think any management approach that's solely dependent on one particular model or tool is always going to be vulnerable to the flaws and inconsistencies that exist in all models…Having a great risk model does not mean that you've really incorporated and integrated risk management into your practices. It needs to be supported at each step and really built up both from the top down, with support from the top of the organization, as well as from the bottom-up. For each of the investment decisions that are made, you've got to have risk management at every step."
The volatile capital market is prompting leaders of financial institutions to closely scrutinise operating costs, as bottom-line growth is becoming more difficult to forecast. As a counter-measure, top-performing financial firms are committed to reducing operational risk and cost, ensuring regulatory compliance, and improving return-on-investment (ROI) on their trading initiatives.
In Bangladesh, instead of equity market, the authorities have given priority to direct investment either in infrastructure or in manufacturing projects. These investments needed separate determination of terms and incentives in each case and thus created competition to capital market. Investors, in particular the institutional ones, found it difficult to participate as foreign direct investment (FDI) mostly offered limited scope and return. Regulatory regime on the other hand had not proved to be reliable in the capital market for institutional investors due to limited scope in portfolios and in volume.
The past decade was marked by the increasing role of FDI in total capital flows. In 1998, FDI accounted for more than half of all private capital flows to developing countries. This change in the composition of capital flows has been synchronous with a shift in emphasis among policy makers in developing countries to attract more FDI, especially following the 1980s debt crisis and the recent turmoil in emerging economies. The rationale for increased efforts to attract more FDI stems from the belief that FDI has several positive effects which include productivity gains, technology transfers, the introduction of new processes, managerial skills, and know-how in the domestic market, employee training, international production networks, and access to markets.
If foreign firms introduce new products or processes to the domestic market, domestic firms may benefit from accelerated diffusion of new technology. In other situations, technology diffusion might occur from labor turnover as domestic employees move from foreign to domestic firms. These benefits, in addition to the direct capital financing it generates, suggest that FDI can play an important role in modernising the national economy and promoting growth. (World Development Report, 2000).
However, consumer preference will remain the main attraction for capital to be invested and in Bangladesh vast majority of the population as consumers either unable or unwilling to exercise any preference due to lack of reliable and sustainable source of income generation.
Investor's motivations for investing in emerging markets and determinants of investment location differ among and across the economic sectors. However, certain general factors consistently determine which markets attract the most FDI. First, market size and growth prospects of the host country play an important role in affecting investment location since FDI in emerging markets is increasingly being undertaken to service domestic demand rather than to tap cheap labor. Secondly, wage-adjusted productivity of labour, rather than the cost of local labor that will increasingly drive efficiency-seeking investments firms that use Emerging Markets as export platforms. Thirdly, the availability of infrastructure is critical. Emerging markets that are best prepared to address infrastructure holdups will secure greater amounts of FDI.
Lastly, except in some sectors, tax incentives (holidays) do not play an important role in determining investment location, although reasonable levels of taxation and the overall stability of the tax regime do. In addition, a reasonably stable political environment, as well as conditions that support physical and personal security, is an important benchmark in deciding any adverse changes in the investment by the multinationals and institutions.
Corruption and governance concerns will have a significant bearing on investment prospects. The investment regime, environment for business-including the business licensing system, the tax regime, and the attitude and competence of the bureaucracy are very important to investors. Recent crises have focused perceptions of regulatory risks and greater attention is now being highlighted on the legal framework and the rule of law. A predictable legal system, which among other things, respects the sanctity of contracts and facilitates a level playing field, will further enable emerging markets to secure large amounts of FDI on a sustained basis
Political risk that investors face can differ in terms of the incidence as well as the manner in which political events affect them; depending on the incidence of political risk, where all foreign operations are affected by adverse political developments in the host country or where only selected areas of foreign business operations are affected.
The unexpected imposition of capital controls, inbound or outbound, and withholding taxes on dividend and interest payments, unexpected changes in environmental policies, sourcing local content requirements, minimum wage law, and restriction on access to local credit facilities, and restrictions imposed on the maximum ownership share by foreigners, mandatory transfer of ownership to local firms over a certain period of time and the nationalisation of local operations of multinationals are known criteria for institutional and other investors to evaluate in making determination of their investment decisions..
The frequency of expropriations of foreign-owned assets peaked in the 1970s, when as many as 30 countries were involved in expropriations each year. Since then, however, expropriations have dwindled to practically nothing. This change reflects the popularity of privatisation, which, in turn, is attributable to widespread failures of state-run enterprises and mounting public sector borrowing around the world.
In Bangladesh, there is a perceived "myth" in vogue and an illusion is suffered that FDI will increase GDP (gross domestic product) and reduce balance of trade deficits. In fact, FDI may cause the opposite impact in the economy as investors' platform may not always be in conformity with national planning priorities.
FDI, in particular investment through capital market platform are controlled by complicated and contradictory "multi-sector" and "multi-national" administrative priorities and regulatory regimes upon which the investors and managers alike will seek to get best "mean options" to achieve best results by taking advantage of interdependency of weaker market structures. Thus in the chain some markets just sustain itself by participation without any obvious growth or benefit.
In Bangladesh, with outside help, capital market restructuring and tooling was completed but both the markets in the country lack competent and professional management which is lingering the teething problem in day-to-day operations; as well as several hic-ups and wholesale manifestation of corrupt manipulation by insiders and outsiders left the markets in such state that both local and international institutional funds managers have become very weary of them.
Long-held practices of bureaucratic regulatory regimes were tinkered with and many attempts to amend them by the political leaders created ineffective institutions and provided some ill-conceived incentives for capital mobilisation but no appreciable results could be mentioned. Lack of coordination and cooperation between and among government agencies left both the Board of Investment (BoI) and Privatisation Commission with the showing of dismal performance while the markets elsewhere in the region attracted very appreciable "investment growth".
Domestic individual investors are mostly motivated by quick return and in the spirit of gambling spree often caused disarray in the market that harmed the effectiveness of regulation in place, and caused mass victimisation of the "curb-market investors". Lack of experience, ambiguity of the management objectives and failure of the government to install effective and efficient regulatory regime to govern the markets have become the hallmark of Bangladesh's economic projections.
The writer is an economist, business consultant and President of Bangladesh Myanmar Chamber of Commerce & Industry (BMCCI). kbahmed1@gmail.com
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