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The Edge

By Tan Choe Choe
Investors in emerging markets, including Malaysia, lack avenues to deploy domestic savings while facing poor risk-adjusted returns on capital market products, mainly because of higher volatility, according to McKinsey.
“They (the investors) put a large part of their savings in physical assets like real estate and gold, and bank deposits. The limited investments in financial assets are mostly in government bonds, AAA-rated corporate bonds, and equities,” said the consulting firm in its recently released report entitled “Deepening capital markets in emerging economies”.
They also get poor risk-adjusted returns on capital markets, it said, based on the average Sharp ratio of 0.8 between 2008 and 2015 seen for equity assets. The markets included here are Malaysia with Sharp ratio of 0.6, China, India, Indonesia, Pakistan, the Philippines, Thailand and Vietnam. Any reading below 1.0 indicates the return on investment is less than the risk taken.
“The inability to match long-term savings with future pension and health requirements, combined with ageing populations, risks creating a generation of poor retirees,” McKinsey said.
According to one of the report’s co-authors Joydeep Sengupta, Malaysia has the deepest capital markets in equities, government and corporate bonds, especially Islamic sukuk bonds, among emerging economies.
“However, it lacks a mature securitisation market, with few offerings for long-tenure products to domestic investors, and faces high volatility in equity market returns,” said Sengupta, who is also managing partner of the Asia-Pacific Banking Practice at McKinsey, in an email interview with The Edge Financial Daily.
In addition, the country isn’t faring too well in terms of quality of pricing information it provides, according to the McKinsey report, as it is ranked 17th or “inefficient”, ahead of only Vietnam, Pakistan and Chile, among 20 countries weighted.
Pricing information from capital markets offers a useful indication for the allocation of financial resources to the most attractive sectors in the economy, said Sengupta.
“Malaysia has fared less well in this parameter as capital markets pricing does not effectively differentiate performance of attractive sectors in the country, partly due to a current insufficient breadth of investors.
“Our experience suggests this could be addressed through greater access to a wide variety of investors with differentiated investment philosophy and capabilities, who could appropriately price assets especially in ‘new’ sectors like technology. Managing government fiscal deficit would also help to ensure investments in the private sector are not crowded out.”
On improving risk-adjusted returns, Sengupta said: “From our experience, sustainable performance of capital markets, including better risk-adjusted returns, lies in implementing key foundational policies. This would include a small number of critical policy decisions that help create foundations of longer-term growth such as creating a liquid benchmark asset, stimulating demand for and supply of capital, and having free markets.”
Quite simply, if Malaysia enacts and enforces improved market architecture and foundational policies, it will help to create an environment for improved investment opportunities, he said.
Still, there’s one thing Malaysia has been doing well. “Overall, Malaysia is one of the most developed capital markets among emerging economies in the McKinsey Asian Capital Markets Development Index ... [in fact,] Malaysia is outperforming other emerging economies in development of its capital market.
“In particular, issuers have access to sufficient debt and equity financing; there is predictable funding from foreign institutional investors; [the] real cost of equity and debt is quite competitive, and investors get a good mix of equity and debt investment opportunities.”
Malaysia scores a 3.25 out of 5 in the development index, ranking 5th in the list led by Japan (4.0), followed by Australia (3.95), South Korea (3.45) and Singapore (3.40).
“Malaysia took the initiative early to demutualise stock exchanges and clearing houses, which had an overall positive effect on the development of its market, as well as removing double taxation rules to avoid hampering the development of its sukuk market, now the market leader of such instrument.
“Malaysia offers attractive avenues to deploy short-term domestic savings and a deep market in terms of investment opportunities available. However, the ability to raise long-term debt is a critical element in establishing a truly well-functioning capital markets.”
Sengupta suggests two ways which Malaysia could potentially establish a longer-tenure market. “Firstly, one of the key requirements for a longer-term debt market is the presence of a benchmark yield curve — typically government securities — across maturities [for instance, one month up to 25 to 30 years] as a reference for pricing other assets. Most emerging markets suffer from low issuance and liquidity in longer-term benchmark assets, resulting in poor benchmark curve at the longer-end. This impacts corporates’ and financial institutions’ ability to rightly price their longer-term bond offerings.
“Secondly, primary suppliers of capital for longer-term bonds are pension funds and insurance companies. Many emerging markets in Asia have low penetration of pension funds. According to Willis Towers Watson’s global pension study in 2017, the pension assets to GDP (gross domestic product) ratio for Malaysia ranks better than other emerging markets. It is 63 per cent in Malaysia versus 5 per cent for India and 1 per cent for China. However, this is still low compared with developed markets such as Australia, the UK and the US, which is over 100 per cent.
“Pension funds invest a large part of their funds in benchmark assets, resulting in limited capital for investments in corporate bonds and equities. The more Malaysia can do to attract investments from this sector, the more developed this aspect of its market will become.”
 
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Kuala Lumpur. Photo: Shutterstock

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The country isn’t faring too well in terms of quality of pricing information it provides, according to the McKinsey report, as it is ranked 17th or ‘inefficient’
