- Pharma, auto, and cement sectors join the surge, showing renewed investor interest beyond traditional big-cap sectors
Interview with Mr. Basharat Khan — Head of Business Development and Research Spectrum Securities Limited
PAGE: Tell me something about yourself, please:
Basharat Khan:Â I am associated with Spectrum Securities Ltd as Head of Business Development and Research. We have our offices in Karachi, Lahore, Faisalabad and have a diverse client based including retail, high net-worth and most of the big local institutions. Formerly, I worked as chief investment officer with Arif Habib Investments, Askari Investments and AWT Investments.
PAGE: Could you give your standpoint on recent performance of PSX?
Basharat Khan:Â It has been a spectacular performance for PSX during 2024. The recovery that started in July 2023 has continued during the current year. From the extremely distressed political/economic situation in 2022 and first half of 2023, the country has managed to pull itself out of the crises. Recent macroeconomic indicators of inflation, current account deficit, fiscal deficit, trade balance point towards major improvement.
Policy rate has been reduced by 700bps from 22% to 15% since June 2024 and it is expected that interest rates will be reduced even further in coming few months. Low valuations have always been the case for Pakistani equities and now when interest rates have declined and which are expected to stay low as inflationary pressure has subsided, equities have started upward rerating. Despite the big increase in Index, valuations have not stretched and based on basic parameters of price to earnings, price to book and dividend yields, investors should be less fearful about making allocation to equities. There are three big market cap sectors in Pakistan: banks, oil and gas and fertiliser. After the big surge in prices of stocks in these three sectors during past sixteen months, other sectors have recently joined the rally such as pharma, auto, cement. Some industries continue to face headwinds such as textiles and steel and they have underperformed big way during past one year.
PAGE: What are your views about valuations of some leading stocks?
Basharat Khan: Valuations of Pakistani equities have remained under the shadow of macroeconomic headwinds. We haven’t yet witnessed valuation as measured by discounted cashflow, price earning multiple, price to book, moving closer to emerging or frontier markets. Despite more than 100% surge in KSE100 Index, valuation of broader market remains at low level.
For common individual investors and perhaps for many institutional investors, the better approach for equity investment is to invest in index or exchange traded funds. Instead of searching for value stocks and good investment proposition, they should start by making allocation to these funds.
The performance of equity markets is mostly dominated or driven by top weight index stocks. As of Oct 31, 2024 top weights on KSE100 Index are: FFC 7.17%, UBL 5.56%, EFERT 4.24%, OGDC 4.04%, MEBL 3.79%, MCB 3.69%, HUBC 3.67%, MARI 3.55%, PPL 3.44%, SYS 3.14%, BAHL, 3.05%, LUCK, 2.83%, HBL 2.79%. You will notice majority of local equity funds have their allocations closer to these weights as they don’t want to deviate too much against KSE100.
PAGE: How would you comment on foreign investment in PSX?
Basharat Khan:Â Foreign investments have been disappointingly slow. They have been net sellers in the market during this fiscal year, net outflows of $93 million in past four months, compared to $140 million inflow in FY24. These outflows in current year were mostly on account of FTSE rebalancing which removed Pakistan from secondary emerging to frontier market.
Foreign equity investment in Pakistan and for that matter other similar economies is driven by the automatic allocation on the basis of country weights in international indices.
In recent past, market capitalisation of Pakistani listed companies has improved and as a result Pakistan’s weight in frontier market indices has also increased. These improved weights of Pakistani companies in international indices should help in attracting higher inflows going forward.
Of course, these inflows in Pakistan are dependent on how much international flows take place in FTSE or MSCI frontier indices. If these funds get higher inflows, Pakistan will similarly attract more inflows per its weight in these indices. World over inflows and outflows in stock markets are driven by allocation in (exit from) indexed funds.
Similarly, money flow to a particular stock is also primarily influenced by the weight of the stock in an index. Just by having a weight in big indices, new inflows come to index constituents’ companies automatically. International investment in frontier or emerging markets are mostly driven by index funds, they hardly go for choosing and picking individual stocks and making allocation on the basis of valuation or other merit criteria. As a country, you don’t need to sell or pitch them individual companies, rather you have to ensure that the big market cap companies have enough free float and liquidity, which meets the criteria of allocation into these international indices.
PAGE: What is your view on local equity funds?
Basharat Khan: Total size of equity mutual funds was Rs 218 billion by September end 2024. This included Rs 148 billion in conventional and Rs 70 billion in Islamic equity funds. During the past quarter, equity funds size could grow only by small margin of Rs 12 billion (from Rs 206 billion). This shows how small equity funds are relative to the size of equity market in Pakistan, who owns less than $1bn of total market cap of $42 billion. One positive shift during the month of October is that equity funds have seen major inflows as reflected in their net buying of approximately $70 million (Rs 20 billion) during the month. It means total holdings of equity funds would now be near Rs 260 billion by taking into 10% increase in KSE100 during the month. These new inflows into mutual funds came at a time when foreigners were net sellers and it enabled the market to absorb this selling without having any negative impact on share prices. Yields on fixed income government securities have fallen to 12%-14% range in recent days and expectations are that interest rates would stay close to lower double-digit levels, as against over 20% in the previous year. This scenario should help in diverting money from fixed income funds towards equity funds and we can also expect that new money may also move to equity funds instead of the usual fixed income funds. International equity markets are driven by low-cost index and exchange traded funds, where the bulk of money flow into the stock market goes through index and exchange traded funds. Investors prefer these passive investment approach since majority of active fund managers and non-index equity mutual funds most of the time underperform the broader indices.
Here in Pakistan, on the other hand, we have not yet seen any increase in fund sizes of index or exchange trade funds. The adoption to index or ETF investment has been very slow as investors base has not expanded in the country. One may hope, investors learn about these things to avail better investment opportunities in the future.