Nofel Wahid

Does Deutsche Bank have the solution to our volatile stock market?

December 18, 2012
February........TwentyEight 03

Photo: bdnews24.com

This December marks the 2-year passing of the stock market crash. To say that the stock market is struggling would be a gross understatement – almost every indicator of stock market performance suggests that.

But let’s be clear about something from the very beginning. A stock market recovery does not imply that the Dhaka Stock Exchange (DSE) General Index has to rise to the 9,000-10,000 point level it was at before the crash. I am not saying that it can’t reach that level, just that it shouldn’t need to reach that level for us to feel confident about the stock market again.

The incredible rise in shares prices we witnessed over a period of about 15 months between mid-2009 and end-2010 defied all economic logic. The world was in the midst of a severe recession at the time, and although our economy emerged from the global recession relatively unscathed, nothing special was happening in our economy to justify the kind of shares price appreciation we witnessed.

The point being – if you have money ‘stuck’ in the market and you are waiting for the index to rise to where it used to be before you start re-investing, you are probably going to be waiting a very long time.

Instead, what you should really be looking out for is volatility. In finance, volatility – as the meaning of the word itself suggests – is proxied by the range of market fluctuations. Markets are always expected to go up and down, so small fluctuations are par for the course. What is bad, however, are large fluctuations. Why?

A simple explanation is that high volatility undermines investor confidence. It leads people to question whether they will gain in the long-run from investing in the stock market. And if enough people come to believe that they will lose money from investing in the stock market, you end up with in a situation where high volatility leads to a self-perpetuating downward spiral in the market.

So is that what happened in the DSE? The chart below shows the range of share price returns on the DSE General Index for the last 5 years.

Chart: Volatility in the Dhaka Stock Exchange

Nofel pic 1Source: Dhaka Stock Exchange

The chart clearly demonstrates that the stock market was relatively stable in the 3 years leading up to the crash, with daily market returns never fluctuating by more than 5%, notwithstanding the one outlier. In comparison, the range of market fluctuations more than doubled after the stock market crashed, indicating that the market had become more volatile. And although volatility has eased over the last 2 years, it is still higher than what it used to be before the crash.

The Government has of course tried a number of different policy solutions to resolve this crisis, ranging from setting up a Tk 5,000 crore investment fund to bailing out investors by waiving their interest burden. Those measures may or may not have helped at the margin, but they have not been very effective in the overall scheme of things.

There is a good reason for this failure. None of those policies address a fundamental issue that undermines investor confidence in our stock market. And that is, retail investors don’t know who to trust when it comes to the information they need to trade.

Retail investors in Bangladesh essentially trade based on ‘advice’ from family and friends, even strangers. They depend upon, figuratively speaking, a million different people telling them a million different things, and are then left wondering who to trust for good advice. Investing in the stock market does not have to be so stressful or perilous.

An important element of greater inclusion and participation – which is an important developmental goal because it makes markets more liquid and less volatile – involves making sure that retail investors have the right products to invest in. That, their investment objectives are met by the product choice on offer to them.

This requires considerable interaction between money managers and investors to understand the latter’s needs and to innovate and create investment products accordingly. Sadly, our financial industry – mostly represented by the banks, but other types of financial institutions too – does not have the professional expertise or the proper systems and technologies in place to perform those functions effectively.

And that is where Deutsche bank comes in.

How? Why Deutsche Bank? Why not any other international bank?

The main reason is because in September 2011, Deutsche Bank (DB) – one of the largest investment banks in the world – launched an Exchange Traded Fund (ETF) targeting the Bangladeshi stock dmarket. It is the only ETF in the world that targets Bangladesh, but has just $7 million of assets under management. In finance, that’s peanuts, and it has to change!

But before I get too ahead of myself, let me briefly explain what an ETF is. It will help to highlight why DB’s Bangladesh ETF is so important.

An ETF is an investment fund that ‘tracks’ the performance of an index. For example, when a stock market index rises by 1%, ETF investors who target that stock market also see their returns rise by 1%. Similarly, ETF investors lose money in the same proportion as the overall market fall. In other words, ETFs try to exactly match the performance of the underlying index they target. That is what is meant by ‘tracking’.

This tracking of a stock market’s equity index is very important because it enables ETF investors to minimise their risk exposure by diversifying their portfolio. In finance, it is well-known that holding a wide variety of stocks produces better results than holding large quantities of one stock. The principle at work here is, as that age-old saying goes – don’t hold all your eggs in one basket!

That said, portfolio diversification is a very time-consuming and expensive exercise in practice. For example, if you wanted to invest Tk 5 lakh in a perfectly diversified portfolio of DSE shares, you would have to buy shares in all 513 companies listed on the DSE. You would also have to make sure that your weighting on each company was the same as in the market in order to be able to replicate the overall performance of the market.

Not surprisingly, that is an almost impossible task for small retail investors to manage. ETFs employ professional money-managers who perform that diversification task for investors.

The fact that an ETF targeting Bangladesh even exists is quite remarkable. But what is blatantly unfair is that international investors can invest in DB’s Bangladesh ETF, by virtue of its location in Singapore, but the product is not available to Bangladeshi investors who arguably need that service the most.

But there is a silver lining to all this doom and gloom.

Standard Chartered Bank, City Bank (a Bangladeshi bank) and Deutsche Bank recently sponsored a first-ever ‘Bangladesh Investment Summit’ in Singapore. This Summit brought together Bangladeshi businesses, government officials and international investors to promote Bangladesh as an investment destination.

If there is one outcome to have come out of that Investment Summit, I hope it is that SCB or City Bank has started negotiations to become a local distribution agent of DB’s Bangladesh ETF.

Distributing an ETF product in Bangladesh would enable our local investors to gain the right kind of exposure (meaning well-diversified) to the stock market, as well as benefit from Deutsche Bank’s expertise as a well-reputed international investment bank that knows how to handle money professionally. It will also help rebuild confidence and trust in our stock market by taking small retail investors out of the perilous business of relying on informal advice to pick individual stocks to invest in.

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Nofel Wahid is an applied economist.

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5 Responses to “ Does Deutsche Bank have the solution to our volatile stock market? ”

  1. Rana Sarkar on December 26, 2012 at 10:06 pm

    This was a very informative write-up. But if the government is actually not sincere about the market, then fall like this is bound to take place.

  2. Nihar on December 26, 2012 at 10:03 pm

    I want the criminals to be brought to justice. Why would we the small investors have to pay for their crimes?

  3. Lipi on December 26, 2012 at 10:00 pm

    I admit that little or no knowledge about the market did play a big role in the debacle, but what I cannot condone is those who took advantage of their gullibility would get away with their crime.

  4. Emon on December 26, 2012 at 9:57 pm

    The government doesn’t seem to care that much about the share market debacle.

  5. Dr.Md.Sayedul Haque on December 20, 2012 at 5:52 pm

    Salam first, I am a doctor having recent involvement in stock trading in DSE. Now in loss about 60%.Your graph shows market volatility easing.Do you suggest me to buy some new shares to recover the losses? I will be grateful if you send me a message in my cellphone -01922450000. I stay in Dhaka city.Thanks.

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