July 23, 2023 (MLN): Jury is out. Equity and (global) bond investors are rejoicing. In Pakistan, the broader KSE 100 is up ~15% from 40,000 on June 23, 2023. The sharp run-up is a clear sigh of relief for many as equity losses are reduced and economic clarity abounds. Merely 2-5% of total investors would have been lucky to time the bottom. Despite a steep rally, some investors are selling continuously. 

In Pakistan, equity markets are dominated by mutual funds, individuals, insurance companies, foreigners, and companies. The zero-sum game dictates someone is selling and others are buying. Statistically, from the KSE 100 Index 40K bottom levels,  Mutual Funds have sold stocks worth $12m while foreigners have bought a similar amount of shares. The question is why. 

Attractive 20-22% returns in fixed income are generational high. This is easy money for risk-averse investors. Fund Managers derive comfort from telling investors that we are "profit taking" while in essence, they are reducing unrealized losses. The very performance reports and investors' calls were rampant with less than 4x P/E of the index and 2-3 P/E of blue chip defensive sectors with double-digit yields. Then why panic and why rush? 

Mutual funds typically charge a 2% management fee on equity funds from investors who hope to earn higher returns than fixed income. Fixed income, in comparison, offers a lesser ~0.5-1% management fee per year to AMCs. Thus, by earning half the fee – though rising at a fixed income rate – mutual funds may not be too aggressive to take bold concentrated bets. Their stress levels are lesser with risk-free assets with less skin in the game. In fact, most of the top funds mimic the index with 40-60% same allocations as Index. Long-term alpha returns (higher than the index) are hard to sustain and observe globally. 

It may also be the case that equity investors themselves see the rally as a short-term spurt and want to switch away from the asset to fixed income. Mouth-watering money market fund returns are indeed tempting for those investors stuck in equities for years and are losing hope. One genuine possibility is the Investment Committee viewing medium-term equity returns to offer less than risk-free fixed income returns of 15-17% without structural reforms, as alarmed by the IMF. 

Stock and sector picking is tricky business. In the latest budget, taxes have increased on real estate transactions as well. So two most famous asset classes are cheap but with caveats. In the current IMF's forecast, inflation may drop to 16% on June 24 signifying lesser than expected cuts in interest rates. With 18-22% interest rates in the fiscal year, risk-taking is muted at best. 

The smart money – buybacks and big boys – must be sniffing blood and accumulating for a 5-10 year run. For equity addicts, it's vital to remain invested throughout the booms and busts while humbly learning from cycles to capitalize on valuations when juice is squeezed.

Pakistan's long-term P/E is closer to 6x, whether we get there or not is a different question. Specialist mutual funds have doubts, investors must check their time horizon and risk appetite to think otherwise.

The author is an independent economic analyst and writes on Twitter and Linkedin.

Posted on: 2023-07-23T17:39:52+05:00