February issue 2009

In November 2007, Anwar Shaikh invested Rs 550,000 from his pension and provident fund savings in a mutual fund — which trade mostly on the stock exchange — run by a leading commercial bank. The sales agent of the fund promised him attractive returns on his savings, telling him that the returns would be higher than any other investment scheme due to the unprecedented rise of the stock market. Soon after, the KSE crossed the psychological barrier of 15,000 points for the first time, eventually peaking at 15,737.32 on April 20, 2008. On his agent’s advice, Shaikh invested another Rs 50,000 in the fund.
Shaikh’s dreams of a windfall profit were shattered in just a few weeks, as the stock market experienced a sudden plunge. By June 2008, the KSE-100 index had lost one-third of its value due to the global financial crisis, domestic instability and increases in the rate of interest. This crisis was particularly severe on small investors, some of whom started ransacking stock market buildings.

Meanwhile, on August 28, 2008, the Securities and Exchange Commission of Pakistan (SECP), in attempt to control the blood letting, imposed a floor of 9,144 on the stock market, effectively halting most activity as everyone wanted to sell and there were no buyers at such a high floor. After finally admitting this step was a failure, the SECP removed the floor on December 15. After being unable to sell for nearly four months, investors got rid of their stocks in a hurry, causing the index to nosedive to about 5,000 points.

In the carnage, many KSE members suffered huge losses, two of whom were declared defaulters by the National Clearing Company of Pakistan Limited, causing them to lose their seat at the exchange. Many other members are also on the verge of default.

By far the worst hit have been the small investors, who blame the floor mechanism for their steep losses. Kausar Kaimkhani, president of the Pakistan Association of Small and Medium Investors, contends that the government saved the large brokers at the cost of the small investors. “We were demanding that the government stop trading in the market, but instead it introduced the floor mechanism, which caused huge losses to the small investors,” says Kaimkhani. The number of small investors, according to Kaimkhani, has shrunk to its lowest levels and those who still remain have suffered massive losses. He blamed the government, the Central Depository Company, the management of the stock exchange and the State Bank of Pakistan for the predicament of small investors and said all the relevant institutions had failed to take appropriate measures to control the situation.

Kaimkhani alleges that, in an attempt to circumvent the floor, brokers were unofficially trading shares among themselves. He also says that brokers were getting loans from banks against the shareholdings of small investors. He says that it is illegal to get loans on the shares of others, but the central bank did not take any action to curb this practice. Small investors had also been demanding a government bailout which, so far, has not been forthcoming.

Along with the stock market, mutual funds also suffered huge losses due to the market crisis. During the period when the floor was in effect, the majority of mutual fund managers had suspended pricing, and the issuance and redemption of all their open end funds and collective investment schemes that had direct exposure in the equity market.

Hundreds of thousands of small investors of mutual funds have virtually reached the brink of bankruptcy because of the stock market crisis. There is no ray of hope for these people as the government had mismanaged the situation to such an extent that there is no legal remedy left for the investors to recover their losses. Now, most of the funds are quoting their unit prices at 50% lower rates which means the investors, instead of earning a profit, have lost a big portion of their principal amount.

The mutual fund managers agree that the situation in the stock market has affected the overall investment portfolio in the mutual funds. The credibility of fund managers has also been shattered due to their non-redemption policy.

Apart from the small investors, foreign investors have also stopped investing in Pakistani mutual funds, particularly after Pakistan was excluded from the Morgan Stanley Capital International (MSCI) record and FTSE-100 index, which are the two common benchmarks for world stocks. Both indices include a collection of stocks of all the developed markets in the world and publish their reviews about the performance of several securities of different countries on December 15 and December 20, respectively. Both indices have excluded around 15 Pakistani stock funds from their lists, which resulted in a massive outflow of foreign investment. The main reason was that the exit opportunities for foreign investors and high volume are the main indicators for both the indices to upgrade their ratings of stock funds.

“Earlier, foreign investors were purchasing Pakistani stocks by following MSCI indices, but since Pakistani funds are excluded, that investment is also not coming,” admits Nasim Beg, the CEO of Arif Habib Investment Management Limited.

Analysts do not see a recovery of stock markets in the near future as, according to them, a series of crises are yet to be resolved. There is tension on the borders, and with the World Bank and the IMF reluctant to provide additional funding at this time, there is little hope that foreign investors will return to the Pakistani market.