Put up guard rails before the circus begins: Reducing Bursa’s board lot size

Policy matters require holistic assessments of both the opportunities and potential pitfalls. And if recognised early, appropriate guard rails can be incorporated to protect those who may be vulnerable.

Let us first explain what the announced measures meant and some context.

Shares on stock exchanges are traded in specific amounts, called “board lots”. For Bursa Malaysia (formerly the Kuala Lumpur Stock Exchange), it used to be 1,000 shares per board lot until it was reduced to 100 shares per board lot in 2003. So, yes, this proposal to reduce the size of board lots has been made before (see Table).

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And with effect from Jan 31, 2017, all companies with share capital were migrated to a NO-par value regime, although a company obviously will still have an outstanding number of shares issued. This means a company can simply issue more shares through bonus issues or stock splits. There is no longer the need for double entry of accounts and the value of the share capital reflected in the financial statements will remain unchanged. In other words, the notion of “fractional” shares is no longer necessary. But yes, there is nothing to stop a company from doing so, if it wishes. Whether it is one pizza with eight slices or eight slices of a pizza, it is inconsequential. It requires synchronising its record-keeping.

So, if we sell a pizza for RM40 ($11.60), can we sell one-eighth of a slice of the same pizza for more than RM5? And will we get more customers to buy our pizzas? The answer to both is “YES”. It should. It has become more affordable. There will be more buyers and consequently, the pizza seller should be able to raise its price beyond RM5 a slice and therefore, make more than RM40 a pizza in total for the eight slices. And this is probably the logic behind the decision (we would be happy to stand corrected).

I am sure some have also thought of more insightful, intelligent and knowledgeable reasons. For example, having more investors (big and small) do theoretically make the stock market and the price discovery process more efficient. More relevant, the theory of information economics implies there will be more efficient and faster information gathering and dissemination, which not only makes price discovery more efficient but also reduces risks and may improve valuations.

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An academic paper published in the Capital Markets Review by Nor Elliany Hawa Ibrahim, Kamarun Nisham Taufil Mohd and Karren Lee-Hwei Khaw of Malaysia’s Universiti Utara and University of Malaya finds that market liquidity did in fact increase significantly after the 2003 reduction of board lot size from 1,000 to 100 shares. And, as expected, it was less pronounced for stocks that were already actively traded (see Chart 1).

Unfortunately, that research did not investigate whether stock valuations were also significantly higher. And for good reason. It is a much trickier question to do research on. Are stocks like pizzas?

We have often said that a stock market is a market for stocks. In other words, it is reasonable to assume that as demand for stocks goes up (like pizzas), so will its price. But you buy pizza to consume, not invest for future returns. You buy stocks for its future cash flows to you, not to eat. And since there are thousands of listed stocks, both in the country and globally, can you make a meaningful change to demand — and would suppliers (the listed companies) not take the opportunity simply to issue more shares to capitalise on any price inflation?

Let us leave this question for postgraduate students somewhere to write their thesis on. Suffice for us here that there is no clarity, although we accept that there will be some minor price increases (in particular, for those small companies whose stocks are not highly traded) but only for a truly short duration of time. We certainly cannot think of any credible or mainstream finance theory that would say otherwise.

One other noteworthy point is that even if we reduce the present board lot size from 100 to 10, or by 90%, the impact on “affordability” and liquidity will not be the same as when the board lot was reduced from 1,000 to 100 back in 2003. Mathematically, that reduction was also by 90%. But absolutes do matter. Imagine a stock priced at RM25 a share. From a board lot size of 1,000 to 100, the consideration per board lot is reduced from RM25,000 to RM2,500. To 10 shares per board lot, that consideration per board lot is reduced to RM250.

Anyway, none of what we wrote above really matters. It is just an academic exercise. The real question we want to pose is whether this proposal is made in the interest of the very small investors — by making board lots smaller and therefore more affordable, so that these small investors with their extremely limited savings can make money from the stock market (investing in shares of companies listed on Bursa)?

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Or is it to increase liquidity in the stock exchange and improve profitability of the stock brokerages? Perhaps it is to elevate prices for stocks that will make the tycoons who own these listed companies a little wealthier, and if they are lucky, allow them to sell some of their stocks at higher prices than they would be able to otherwise?

We have no intention to pour cold water on ideas. And as we have repeatedly acknowledged, even at the beginning of this article, the chronic underperformance of shares listed on Bursa must be addressed. Our point is that different objectives require different measures and policies.

Let us take the following facts into account.

Most retail investors “invest” in no more than two to three stocks at any one time. If affordability per investment is only RM250, does it mean the proposal is targeted at small investors with savings of only RM1,000? Even if we double this to RM2,000, is it responsible to encourage people who do not have any significant savings to take the risk of investing in the stock market? And especially if they are not financially literate?

These small investors do have the option of leaving their savings in the Employees Provident Fund, which would have earned them a compounded annual return of 6%, on average, from 2012-2022. By comparison, the FBM KLCI Total Return Index (including dividends) has risen by just 2.2% compounded per annum over the same period. And the FBM KLCI itself has fallen by 11.5% in the past 10 years. So, will these very small investors do better than EPF managers?

Not everyone “invests” in stocks. Indeed, many and especially the small retail investors view trading on the stock market more as gambling. This is particularly relevant since all brokers charge a minimum fee on the transaction for each of their clients. They range from RM5 to RM12 except for Rakuten, which is the lowest at RM1. This is like going to the casino. The house takes a commission and after a while, your entire capital is eaten away by commissions, even if your bets made even profits and losses.

And with a small capital base, where absolute profits will also be small, would they be tempted to borrow to invest, especially if they had a couple of lucky bets? It is unlikely banks or brokers would lend, given that the threshold for bankruptcy has now been raised to RM100,000. So, fun time for loan sharks?

And what will the social costs be? Who will bear them? Who will take responsibility when all these poor little investors lose all their hard-earned savings?

Our point is such policy decisions must be holistic. Both opportunities and pitfalls must be carefully articulated, considered and mitigated. Guard rails must be put up before the circus begins. On minimum commission, in the US, fractional trading is at zero commission.

Should this exercise be piloted with only 100 listed companies, with extraordinarily strong fundamentals and cash flows? Let Bursa be accountable for making this list of companies.

Let this not be a money-making exercise for stock brokerages but to educate and enrich market participants. Let stock brokerages provide analysis and talks for free to these small investors.

We realise there are many who think the performance of shares listed on Bursa can be better if there is more liquidity. Let us assume there are 100,000 such small investors, each with RM2,000 savings to invest annually. That will translate to RM200 million per year in fresh funds, or about RM16.7 million per month. That is about 0.04% of the average monthly traded value on Bursa in 2022. It would hardly move the needle.

But the negative consequences to some of these 100,000 new investors could be extremely severe. Has this trade-off been carefully considered? Perhaps an even more pertinent question is whether liquidity follows stock performances or vice versa. Once again, putting the cart before the horse.

Indeed, will boosting liquidity alone lead to improved performance for stocks on Bursa? While the value of shares traded over the last 10 years has stagnated (see Chart 1), the FBM KLCI has actually fallen quite sharply. In other words, the chronic underperformance of the listed shares is likely not because of low liquidity or trading volume, but poor earnings performance and, as we said before, a weak business environment. Case in point: The return on equity (ROE) and net profit margin for companies listed on Bursa have fallen sharply over the past decade (see Chart 2). Addressing Bursa’s chronic underperformance therefore is an entirely different matter altogether. Do not prescribe medications when you don’t understand the cause.

The Malaysian Portfolio fell 0.5% last week, outperforming the benchmark FBM KLCI, which fell 1.7%, thanks to our high cash holdings. Shares for Insas fell 2.3% for the week. Total portfolio returns now stand at 156.9% since inception. This portfolio is outperforming the benchmark FBM KLCI, which is down 22.6%, by a long, long way.

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