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Unwary investors, beware of stock bubble

Nironjan Roy  | Published: January 23, 2017 20:54:23 | Updated: October 22, 2017 19:53:06

Unwary investors, beware of stock bubble

Constitution of portfolio is very crucial for investing in capital market because this not only ensures steady revenue from overall investment but also prevents the investors from ruining his/her financial position. But composition of portfolio is not an easy task as it requires expertise, analytical skill, familiarization with sources of fund and systematic as well as unsystematic risk of capital market. Usually specially qualified and experienced financial analysts perform this kind of jobs. Moreover the constitution of portfolio for each investor based on the nature of investable fund as well as investor's risk taking capability is another important function. What would be the ratio of investment in risk-free return, low-risk return, medium-risk return and high-risk return is the most crucial factor in determining the portfolio of the investors. In the rule of thump, minimum 35 per cent to 50 per cent of investable fund depending upon the nature and requirement of fund will be retained in risk-free return while the remaining portion may be distributed among other forms of investment opportunities, viz., low-risky return, medium-risky return, high-risky return, etc.   This will of course vary depending upon the nature and size of investable fund and risk appetite of the investors, yet there must be some benchmark parameter which will be followed while forming portfolio. 
I am not sure whether Financial Adviser's appropriate role has been established in the investment houses of our country's capital market. Last October when I went home, I had an opportunity to visit investment houses of some banks but did not notice this type of service being rendered by the Financial Adviser of the respective houses. I hope concerned authorities will look into this matter and will take measures for establishing standard role of investment advisers not only for protecting the interest of general investors but also for the sustainable growth of the capital market.  
INVESTING BANK LOAN IN STOCK MARKET IS MISMATCH: Apart from personal borrowings, some aggressive investors tend to make institutional borrowings for investment in the stock market. The recent decision on maintaining single-digit lending rate will open up easy access to cheap fund what may be easily channelled to country's stock market. Whether recent stock market rise is the result of lower lending rate is very difficult to ascertain because compiling data from money market and capital market and analysing these can only determine this. As for example, if settlement in daily trading in country's stock market increases commensurate with the increase of banks' borrowing, it can be inferred that institutional borrowing might have poured in the stock market. Unfortunately, this type of financial tools and techniques is not yet in use in our country. Even if the restriction is imposed on personal borrowing from bank, the scope of investing business loan in stock market will remain widely opened. Because the common form of business loan in our banking system is plain Overdraft (OD) or Cash Credit (CC), which is the form of free flow of money that may be utilized for any purpose - from spending in vacation to purchasing luxury car and investing in the stock market.  
Borrowing money from bank and investing in the stock market creates a complete mismatch which eventually exposes the investors at high risk of selling stocks at any given time regardless of the market trend. Bank loan usually carries short maturity, which is usually one year, whereas buying stocks and securities is a long-term investment and the investors are required to wait until the opportunity comes to offload their holding so that gain form capital market may be reaped. Therefore, borrowing from banks and investing in the stock market is a complete mismatch which is not desired at all. 
However, if the lending structure is specially designed matching the features of capital market, this may be helpful for investment in stock market because this type of loan structure does not have fixed maturity and carries very low interest rate. Borrowing this specially structured loan and investing thereof in the stock market, investors are not vulnerable to forceful offload his/her holdings, particularly in the bear market. However, this type of specially structured loan for stock market is very uncommon and may be non-existent in our country. Therefore, investors must be very careful while making investment decision from institutional borrowings.   
CAPITAL MARKET NEEDS MUTUAL FUNDS: For steady and sustainable growth of capital market, the presence of mutual funds is imperative. A mutual fund is managed by professional fund manager who undertakes extensive research and in-depth analysis. Moreover, the managers of mutual funds have wide access to all available sources of information, so they can take well-informed investment decisions which are much better than individual investors. Besides, the market capital of our stock market has increased manifold intensifying the depth and scope of the market, so it has now reached beyond individual investor's capability. Under this situation there is no substitute to the presence of mutual funds. One of the advantages of mutual funds is that risk associated with stocks comprising the fund is mitigated among the investors. 
In the developed world, capital market is more volatile and unpredictable, so general investors have been protected through introduction of mutual fund. Although there are some loopholes in calculating income from mutual fund, yet this instrument is very popular among the general investors in developed countries. Mutual fund not only provides some sort of protection to the investors but also generates some steady income for them. 
For some mysterious reasons, the instrument of mutual fund has not received acceptability in our country's stock market. It was expected that banks and other financial institutions would play their proactive role in establishing the reputation of this instrument among the general investors. While serving in the Securities and Exchange Commission (SEC), I was always in strong favour of bringing banks and financial institutions in the country's capital market. They have been given that opportunity too but their role in the capital market is not found as praiseworthy as was expected. As a result, the condition of general investors remains at stake. Time has come to conduct in-depth research and analysis to unearth the reason of mutual fund's failure and based on findings, corrective measures must be taken. 
However, the recent rise in the stock market is definitely a good omen, specially when this is found to be at par with the country's economic development. But stringent monitoring and vigilance will be needed so that sustainable growth of capital market can be ensured. There must be clear-cut demarcation between capital market and money market, particularly at a time of historically low interest rate regime. Measures must be taken to prevent people from pouring in their hard-earned savings and borrowed money in the stock market because of low interest rate in banks. This extra care is needed so that another bubble is not created in the country's stock market.    
Nironjan Roy, CPA, CMA
Banker, Toronto Canada.
 nironjankumar_roy@yahoo.com
 

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