Rise of portfolio investment

By Sahala Sianipar

ATHENS, Ohio, U.S.A. (JP): Portfolio investment has received significant attention due to its critical role in the development of emerging capital markets. In a conference to commemorate the anniversary of the Indonesian capital market in August 1996, conference participants agreed that the Indonesian market would continue to be highly volatile given the dominance of foreign investors through their portfolio investment in the market.

The result was not surprising, nor was it new to many of the market players in the region. During the seminar sponsored by the Jakarta Stock Exchange (JSX) in October 1995, discussions between both the regulatory body and market participants from the region touched on the issue of sustainability of portfolio investment in emerging markets such as Indonesia.

The conference also raised the issue of possible integration of capital markets in the Asia-Pacific region as one way to mobilize greater resources to finance regional development. The increasing flow of portfolio investment to emerging markets in Asia and Latin America challenges market participants to continuously develop and improve their markets' infrastructure to attract more funds.

Market infrastructure encompasses wide-ranging areas from market regulations, trading practices, to political stability. Recently, the Korean Supreme Court sentenced two ex-presidents for their wrongdoing during their administration of that country. The ruling did not affect the market significantly. On the other hand, the continuous decline of the Thailand market could partly be caused by the instability in the current government that leads to the declining of investors' confidence in the market. The Indonesian market has also been affected by the recent political climate in the country despite the positive fundamental macroeconomic policy instituted in the country.

Table 1. Emerging Equity Funds of Selected Asian Markets (1993- 1995) (Assets in US$ million)

Countries 1993 1994 1995

No. of No. of No. of

Assets Assets Assets

Funds (US$) Funds (US$) Funds (US$) Indonesia 22 860 28 729 26 680 Malaysia 17 995 21 1345 19 918 Philippines 10 670 12 655 13 551 Thailand 26 2860 27 2662 30 3000

(Source: International Monetary Fund, 1996).

Another case study illustrating the direct correlation of political stability and capital flows was the Mexican economic crisis in late 1994. As the result of the crisis in Mexico, portfolio capital went to most developed nations during the first semester of 1995 because of their political and economic stability compared to developing markets. Although Mexico successfully settled its financial uncertainty in the first semester of 1996, several fundamental political and economic discrepancies remain to be addressed.

Portfolio investment is characterized by its short-term outlook. Portfolio managers are not interested in staying in the market for the long-term; they search for markets that can provide higher returns for their investors. On the other hand, emerging markets require longer periods to develop and enhance their market infrastructures. The gap between the desired (i.e. efficient, transparent, and liquid market) and actual condition of the market (i.e. competitiveness gap) contributes to the volatility of the market. Political and economic initiatives should not be embraced to merely maintain the short-term attractiveness of the market; policies will need to be implemented to minimize the market's competitiveness gap.

One important factor to ensure a closer competitiveness gap is greater market transparency and rules enforcement. Most emerging markets in Asia have used the electronic trading system that enhances market transparency and efficiency. However these emerging markets are still insiders markets. Investors cannot just rely on information disseminated by Reuters, Bloomberg or other data providers to make investment decisions. Information has not been equally accessible in emerging markets. Continuous development of transparency and rules enforcement will contribute to minimizing the competitiveness gap in emerging markets.

Both the conferences that were sponsored by the JSX and the Capital Market Supervisory Board on the Indonesian capital market discussed the lack of a strong base of domestic investors in the market.

Despite the absence of a strong base of domestic investors, the Indonesian market, along with its Asian counterparts, continues to be popular for portfolio investment. In 1992 Asian markets received a net portfolio investment of US$ 9.8 billion and by the end of 1995, the figure had doubled to US$ 18.5 billion (IMF, 1996).

Certainly a stronger base of domestic investors could definitely increase liquidity in the secondary market which will attract more foreign capital. Wealthy investors in Asia's emerging markets would rather invest in more developed markets, such as Singapore or Hong Kong, given the lower competitiveness gap and volatility, and their investment portfolio targets in their home markets (i.e. intra-region portfolio investment). The challenge for market policy makers lies in their ability to continue to attract such investment and at the same time, provide greater market access for domestic investors.

The continuous developments in the global market will serve as a catalyst of portfolio investment across emerging markets. More markets have launched electronic system that allows greater cross-transactions. The currency market exemplifies a global market given its vast trading volume and the continuous nature of transactions. Geographic and time differences do not hinder the rapid development of the currency market. Daily foreign exchange transaction has increased from US$ 880 billion in 1992 to US$ 1 trillion in 1995 (Bryan & Farrell, 1996, Market Unbound). The equities market has not yet matched the level of the currency market, but certainly the trend seems to follow the direction of the currency market. Continuous deregulation and improvement in trading practices will bring more markets closer that will create greater opportunities for portfolio investment.

Having said all of the above, the outlook for portfolio investment in emerging markets is encouraging. More emerging markets are challenged to minimize their volatility by enhancing their market competitiveness and that will ultimately benefit both domestic and foreign investors. That means a rigorous task ahead for market policy makers to initiate effective strategies in creating a conducive investment environment.