Foreign investors have been huge sellers on Bursa Malaysia, withdrawing nearly RM21.3 billion ($7 billion) so far this year. This is the highest annual net outflow since at least 2010. Foreign ownership, which had fallen to just 21.4% as at June 2020 — the lowest level in a decade — would probably have dropped further. In fact, foreign portfolio funds have been taking money out of the stock market every year since 2014, except in 2017.
As we wrote a couple of weeks back, robust trading volumes on the stock exchange so far this year are attributed mainly to domestic retail investors, many with excess cash from the six-month automatic loan moratorium. This source of liquidity will dry up, however, when the moratorium ends this month. While we do not think it will trigger a price collapse, it is likely to take the wind out of the current momentum rally.
This week, we examine some of the possible reasons behind this multi-year foreign investor sell-off and assess the likelihood that these portfolio funds will return to Bursa — and provide the next catalyst for local stocks.
Why have foreign investors been net sellers in six of the last seven years?
We already know of one reason that foreign investors have been selling — indeed, why the broader market has underperformed. The FBM KLCI and FBM Emas Index have fallen at an average compound annual growth rate (CAGR) of -2% and -1.3% respectively between 2014 and 2019.
According to data from AbsolutelyStocks, earnings (for the 842 companies that stayed listed from 2014 to 2019) have fallen by an even larger quantum, at a CAGR of -4.4% over the same period (see Chart 1).
Thus, despite the share price underperformance, Bursa-listed stocks are in fact pricier in terms of price-to-earnings valuations — relative to its historical average as well as against regional peers.
Net profit margins (for all companies except for financials and real estate investment trusts, or REITs) have been in a broad decline, from an average of 9% in 2014 to just 5.3% in 2019.
All sectors except financials, healthcare and technology reported negative earnings CAGR while REITs’ earnings were flat over the five-year period. While the external factors-driven commodity bust affected the earnings of energy and plantation stocks, the downtrend in the other sectors was mostly due to domestic structural rather than cyclical issues.
These included fallout from the crowding-out of the private sector by government-linked companies (GLCs) and government-linked investment companies (GLICs), chronic underinvestment in productive assets, technology, research and development and innovation, as well as over-reliance on low-skilled foreign labour and failure to move up the value chain, which resulted in increasing pricing pressure from newly emerging markets, digitalisation and technology disruption. There were also widespread rent-seeking activities.
But the falling profitability of Malaysian-listed companies is not the only reason for the persistent foreign selling. In fact, expanding our analysis to the flow of foreign money into the Malaysian bond market also showed a downtrend from the peak in 2014, though to a lesser extent.
Cumulative net flows have more or less stagnated over the past three to four years — even with interest rate differentials between the 10-year Malaysian Government Securities (MGS) and Treasury bonds moving higher. This is probably due, at least in part, to ringgit weakness versus the US dollar — against the backdrop of declining current account surplus (see Charts 2 and 3).
Comparing Malaysia’s outflows to those in the region
The next logical question would be, is the poor performance of the Malaysian capital markets — stocks and bonds — due solely to country-specific reasons or are there broader regional issues?
Bond markets in Thailand and Indonesia, in fact, reported rising foreign fund inflows over the past few years. We believe this is partly because of the strength of the Thai baht (thanks to robust current account surplus) and the relatively wide interest rate spread in Indonesia.
Both countries are also suffering, however, from persistent foreign equity fund outflows. And unlike companies listed on Bursa, corporate earnings have been generally on the uptrend (see Charts 4 and 5). Given the strengthening of the Thai baht and improving corporate earnings, one would expect stronger foreign fund inflows to its stock market. Why is this not the case?
Foreign money flowing into China, India and other newly emerging nations
We suspect the lacklustre foreign interest in all three stock markets has to do with the rise of China and, to a lesser extent, India. Both countries recorded strong foreign fund flows into their capital markets (see Charts 6 to 8).
Chinese companies have expanded very quickly and grown in prominence globally. Big Tech companies such as Alibaba Group Holding, Tencent Holdings, ByteDance and Meituan Dianping are now among the largest in the region and comparable to their peers in the developed world.
Financial stocks, benefiting from years of robust economic growth and the huge domestic consumer market, dominate the Shanghai Stock Exchange. Most recently, Nasdaq-like boards were created for fast-growing and high-tech companies in Shanghai (STAR market) and Shenzhen (ChiNext) and they are expected to attract even more portfolio dollars from the rest of the world.
Chinese companies — listed on stock exchanges in China and Hong Kong — are increasingly investable as the country relaxes restrictions on foreign access to its rapidly growing capital markets, now among the world’s largest by value.
For example, the highly anticipated dual listing of Ant Group in Hong Kong and Shanghai is estimated to raise up to US$30 billion ($40.8 billion), which would make it the biggest IPO on record, narrowly topping that of Saudi Aramco’s.
We expect China to continue to attract increasing allocations from global investment portfolios on the back of upbeat longer-term growth prospects — the country remains one of the fastest-growing economies in the world. That will mop up liquidity earmarked for emerging markets as a whole.
This reality is further underscored by the actions of major index providers, such as MSCI and FTSE Russell, which have been gradually raising the weightage of Chinese stocks and bonds in their global benchmark indices — widely followed by investment funds — at the expense of other developing markets.
We believe China is also the reason that foreign direct investment (FDI) has been declining-stagnating, both in absolute dollar amount and as a percentage of GDP in Malaysia, Indonesia and Thailand (see Chart 9).
The sheer scale of investments flowing into China — the world’s second-highest recipient of FDI after the US and taking up to one-fifth of total fund flows to the developing world — dwarfs those in the three countries combined.
Coupled with competition from newer emerging countries such as Vietnam and India, it is not surprising that Malaysia’s share of foreign investing dollar has been falling — and may well continue to fall.
What all this means is that Malaysia can no longer take the inflows of foreign money — be it in terms of FDI or the capital markets — for granted or rely on them to drive growth. Future policies should, therefore, focus on better application of domestic savings. We will leave this topic for the future.
Another area to look at is how the country can leverage and interact better with regional economies, including China.
Take, for example, Singapore, which is faring much better than its closest neighbours in terms of FDI and capital market inflows. The country ranks third in terms of global FDI destination. This is driven by its status as a regional financial hub. Tencent and ByteDance recently announced plans to invest billions in the city state, making it the base for their regional expansion plans.
In addition, Singapore companies, including the big banks and property developers, have expanded their global footprints and exposure to other Asian countries, including China. And they have, by and large, performed comparatively well earnings-wise, reporting improving margins.
The Global Portfolio closed 0.9% higher for the week ended Sept 17, boosting total portfolio returns to 32.7% since inception. This portfolio is outperforming the benchmark MSCI World Net Return index, which is up by 20.3% over the same period.
Builders FirstSource, BMC Stock Holdings and Taiwan Semiconductor Manufacturing Co led the top-gainer list, whereas Microsoft, Ericsson and Alphabet were among the biggest losers for the week.
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