Rise of portfolio investment

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.