With about 4% of public listings on Bangladesh’s stock exchanges held by foreigners, Shahidul Islam estimates foreign holdings in Bangladesh’s public equities are at, or near, their all-time high. Mr. Islam is the CEO of VIPB Asset Management Company, an asset manager focused on growing Bangladesh’s nascent market for mutual funds. Mr. Islam, age 41, is a CFA Charterholder and has 14 years of experience in Bangladesh’s banking and capital markets. Mr. Islam kindly agreed to give his perspective on the investment climate in Bangladesh’s stock markets for this interview.
Currently, VIPB manages two closed-end mutual funds. The firm is also seeking to add an open ended mutual fund. Mr. Islam is the first to note the funds trade at significant discounts while also noting that “before the bursting of the stock market bubble in 2010 many closed-ended mutual funds were trading at premiums in the range of 200%-400%.” His closed-end funds are listed on both the Dhaka and Chittagong stock exchanges where foreign investors may buy shares in the funds the same way they may access other stocks, bonds and mutual funds listed on those exchanges.
Jon Springer: Under the old Dhaka Stock Exchange index, the stock exchange plummeted in excess of 50% from highs in November 2010 to its lows in April 2013. What brought the stock market down?
Shahidul Islam: Bangladesh’s stock market was massively overvalued before the crash that started in late 2010. Equity market capitalization increased from Bangladesh Taka (BDT) 209 billion on 1 January 2005 to BDT 3,253 billion on 5 December 2010. New companies that got listed during that period of time accounted for BDT 1,008 billion of the increase. Therefore, the stocks that were listed before 1 January 2005 increased in value from BDT 209 billion on that date to BDT 2,245 billion on 5 December 2010, a 974% increase in value in less than six years.
In late 2010, the central bank became concerned about the double-digit inflation at that point in time and started monetary tightening. Perhaps the central bank’s decision to increase cash reserve requirements for commercial banks then triggered the collapse. But, I think the correction was long overdue and the policy intervention was a bit too late.
The new broader DSEX index and narrower DSE30 index [which were both launched in 2013 to replace the old index] are both up between 23% and 32% since their launch at the end of January 2013. Has the market found stable footing? And is the Dhaka Stock Exchange fairly valued? I think the market is pretty close to being fairly valued now. However, Bangladesh’s markets are extremely inefficient and are driven more by speculation than fundamentals. Therefore, I believe the bull-run in the last few weeks has made some stocks overvalued. The others, in many cases, offer good values or are fairly valued.
Springer: About what percentage of investors on the Dhaka Stock Exchange are foreigners and what do you see as the reasons for foreign investment growth?
Islam: Some of the listed companies are subsidiaries of multinationals. Apart from the parent companies’ stake in the listed multinationals, about 4% of the listed Bangladeshi stocks are held by foreigners. Foreign investment in Bangladesh stock market has always been low compared to other frontier markets such as Vietnam, Pakistan and Sri Lanka.
Despite it still being very low compared to other frontier markets, I think foreign holding is at an all-time high in Bangladesh at this moment. Net flows of foreign portfolio investment has remained positive in last few months. I think this trend will continue for some time because valuations of some of the stocks are attractive and local institutions, especially banks, are unable to increase their exposure to the market because Bangladesh Bank, the central bank, has come up with new rules that reduced limits for banks’ exposure in stock market drastically.
Bangladesh does not have too many institutional investors other than the banks. The insurance industry is very small and is at a nascent stage of development. The pension funds are insignificant in size and they almost always invest in bank deposits and government bonds. Most of the retail investors are driven by momentum. They join the bandwagon only when the market shows a sustained bullish trend.
Springer: Your investment funds have outperformed the performance of the stock market indexes. Are there particular sectors of the market that have helped you outperform? Have there been other factors you would highlight?
Islam: Yes, we have been generating more than 13% annual net returns since we launched our funds about 3 and a half years ago. In the meantime, as you mentioned, the stock market collapsed by about 50% before regaining some ground. The main reason for our outperformance is that our funds are not equity-only funds. We invest in stocks, government bonds, corporate bonds, cash instruments and short-term fixed deposits with banks. When we raised our funds in early 2011 we realized that the equity market was overvalued and, therefore, we invested more in government securities and corporate bonds than in stocks. Also, some of our equity holdings generated attractive returns even while the overall market was down. We were also investing in short-term fixed deposits with banks up to the maximum limit permitted by the mutual fund rules. During the last couple of years, short-terms fixed deposits generated about 12% returns.
Springer: Are there any factors from a viewpoint of government policy, infrastructure investment, social indicator improvements or trade agreements that are setting up macro trends in Bangladesh’s economy?
Islam: I think the proliferation of telecommunication and internet is going to play a transformational role in Bangladesh. Total telephone connections increased from about half a million in the early 1990s to 120 million now. Internet access is also spreading pretty fast. As a result educated young people have started doing outsourcing work for foreign companies. I think more internet-enabled outsourcing work is going to be a key driver of Bangladesh’s economy in the next few years.
Also, some initiatives by the government and some non-government development organizations have resulted in tremendous gains in many social indicators such as reductions in infant mortality and increases in access to primary education and basic health care. Life expectancy at birth increased from 60 years in 1991 to more than 70 years now. The literacy rate during that time-frame increased from 35% to about 60%. All these gains are expected to contribute to economic growth in next couple of decades.
Springer: The Dhaka Stock Exchange recently modified its trading platform to T+2 with NASDAQ OMX. What will this do in terms of facilitating an improved investment climate? For example, you are trying to launch an open-ended mutual fund, does this change help with that? Do these changes make it possible for a foreign-based ETF to launch a Bangladesh-only fund?
Islam: Yes, Dhaka Stock Exchange has changed it settlement cycle from T+3 to T+2 recently. It will enhance market liquidity. But I don’t think this change will have significant impact on investment climate. It won’t have much impact on the open-ended fund that we are in the process of launching because open-ended funds are not listed.
Springer: Bangladesh’s GDP grows relatively steadily at about 6% per year. Despite steady growth, beneath the surface there are pockets of growth, bubbles and undervalued sectors. Did government policies play any role in this regard?
Islam: Other than the stock market bubble we talked about, there has been a massive bubble in real estate that culminated in 2010. In the ten years up until 2010, land prices increased 20-fold in some areas of the country. Despite corrections in the prices of apartments and commercial properties in the last couple of years, there are hardly any properties that generate rental yields of more than 2%. I think a gross rental yield of 2% is very low compared to the risk free rate in the country with the yield of the 5-year government bond at about 9.5% currently.
All these bubbles were created because money was too cheap for too long in Bangladesh between 2001 and 2010 and the credit growth was astronomical. Outstanding private sector credit increased from BDT 991 billion on 1 July 2004 to BDT 3,595 billion on 1 July 2011, growing more than 20% annually.
Bangladesh’s GDP growth, as you know, has been driven by remittances from about 8 million Bangladeshis who work abroad and the export of ready-made garments. The ready-made garments industries are labor intensive. Therefore, there has not been too much investment in building factories and other productive capacities. Also, due to indecisions and a lack of government capacity to implement infrastructure projects, the investment in infrastructure has been very low. Therefore, overall capital investment has been low if we compare it with credit growth. As a result, the credit growths and monetary expansions had created asset price bubbles.
Springer: Bangladesh competes with a number of countries that are in ASEAN for factory jobs. As ASEAN plans to launch the ASEAN Economic Community next year, are there any negative or positive impacts to Bangladesh anticipated from the ASEAN Economic Community?
Islam: The ASEAN’s move towards creating a single market within its members will be beneficial for Bangladesh. The trade within the members of the single market will increase and Bangladesh may face less competition from ASEAN countries in its traditional export market in the EU and the US. Also, a common market is expected to accelerate growth within ASEAN and that may create demands for certain goods made in Bangladesh. It’s good to have rich neighbors.
Springer: Why should emerging and frontier market investors add Bangladesh to their portfolio? Why should investors who rotate their investments around other emerging and frontier market countries such as the Philippines, Cambodia, Vietnam, Pakistan and Qatar, consider Bangladesh?
Islam: Bangladesh has its own challenges. The standards of corporate governance and financial disclosures of the listed companies are very poor. The regulators lack authority and human resources. And, from a macro perspective, there are issues such as political uncertainties, weak institutions, corruption and lack of infrastructure.
This said, Bangladesh’s population is larger than any of the countries you mentioned except Pakistan. Also, the population in Bangladesh is homogenous in terms of ethnicity. Therefore, the risk of sectarian conflicts, a common phenomenon in many frontier markets, is low in Bangladesh. Also Bangladesh’s population is pretty young, the average age being only about 24 years.
More importantly, as Bangladesh is one of the most inefficient markets in the world, it offers certain pockets of value to the investors. Total market capitalization of the listed banks in Bangladesh, for example, is currently about USD 4 billion. These banks enjoy roughly 60% market share of the banking industry of the country whose GDP is about USD 150 billion, and it is expected to grow at more than 6% in the near future. I think this level of valuation of the banking sector of a country is a bargain. However, I must mention that there are reasons to be concerned about asset quality of the banks, especially because of the down-turn in the real estate market. Though the extent of real estate financing is not very high in Bangladesh, most of the corporate loans are collateralized by real estate.