IT has been three years since index constructor Morgan Stanley Capital International (MSCI) announced that it would adjust its equity indices so as to take into account free float levels. Back then, there was some hand wringing among our stock market players over the possibility of Malaysia suffering an exodus of foreign funds.
This was because the shares of most of the local listed companies were tightly held. MSCI estimated that Malaysia's average free float (as at June 2000) was only 30 per cent, which put us right at the back of the pack.
Among the some 50 countries covered by MSCI, only China, India and Jordan had lower figures.
The indices have since been adjusted and Malaysia's weighting has indeed gone down, but the anxiety was apparently overdone. The Kuala Lumpur Stock Exchange (KLSE) is far off its peak, but we can chalk that up to a raft of other factors. Life goes on.
However, the potential pitfalls of having too little shares available for trading are still there. The average free float in Malaysia has not budged since 2000.
A head ofresearch reckons that 60 per cent of KLSE companies has free floats of 25 to 30 per cent. “If that goes up, it will be a boost to the stock market,” he says. But that is not likely to happen anytime soon.
Check the substantial shareholdings of our 10 largest companies, going by market capitalisation, and we can see that these have barely changed since 2000.
A large chunk of the issued capital of the perennial top three – the so-called TMT combo of Malayan Banking Bhd, Tenaga Nasional Bhd and Telekom Malaysia Bhd – are in the hands of government bodies and government-linked funds.
And this is if we are only talking about the substantial shareholders, that is, those with at least a five per cent stake each.
Scan through the annual reports' information on the top 30 shareholders. The lists are often dominated by government-linked institutions such as Bank Simpanan Nasional (BSN), Lembaga Tabung Haji, Lembaga Tabung Angkatan Tentera (LTAT) and the various unit trust funds managed by PNB.
For example, Kumpulan Wang Amanah Pencen, the pensions fund of the civil service, appears six times on Maybank's latest Top 30 Shareholders list and seven times on that of Tenaga.
This is not a good sign. Foreign funds prefer to put their money in large-cap companies because of their size and stability. In addition, these funds normally track or benchmark themselves against indices whose constituents include such companies.
In other words, when the foreign funds look to invest in equities, they consider the blue chips first. However, in Malaysia, this can be a problem because a large proportion of these companies' equity is seemingly not available for trading.
Too much money, not enough shares
The chief executive officer of a local asset management company says the bigger funds, especially foreign ones, have trouble picking up stocks of blue chip counters because the shares are tightly held.
“These funds typically trade shares in the hundreds of thousands or even millions,” he explains.
“Don't forget that the foreign funds are US dollar-based. If a US$ 200 million fund – which is actually small by most standards – wants to invest 5 per cent of its money in Tenaga, it has to find 4.3 million shares.”
CIMB Securities research head Toh Hoon Chew points out that when a lot of money is chasing too few stocks, there is a danger that it may lead to a stock market bubble.
He says: “That is why there was a rather noticeable 'scarcity premium' for KLCI (Kuala Lumpur Composite Index) stocks vis-à-vis the region in the 1990s, manifesting itself in higher relative valuation.”
The MSCI's move to free-float adjust its indices has narrowed the premium, but market-watchers say our stocks are still pricey compared with those on other bourses in the region.
Federation of Public Listed Companies (FPLC) president Datuk Seri Megat Najmuddin Megat Khas concedes that the low free float level is “something that is a concern at the highest level”.
He says, “We have suggested that the government released some of its shares. It doesn't need to hang on to all of them. In some cases, it has golden shares.”
In the past, there has been dispute over MSCI's definition of free float, which excludes shares held by strategic investors such as governments, corporations, controlling shareholders, and management, and shares subject to foreign ownership restrictions.
The critics at the time – KLSE executive chairman Datuk Mohd Azlan Hasim was one of them – argued that shares owned by government-linked funds such as the Employees Provident Fund (EPF) and Permodalan Nasional Bhd (PNB) should not be considered as government holdings.
The money, they pointed out, belonged to the funds' contributors, not the government. Furthermore, the funds were managed actively and the holdings were traded in the open market.
It is true that LTAT, PNB, EPF, BSN and Tabung Haji, for instance, make up a motley group. They have separate management, profiles and objectives.
However, there is justification for placing them under the government banner. Certain ministries oversee these funds, primarily because these institutions handle money from the public. Key executive appointments need the government's endorsement.
It is interesting, though, that MSCI does not automatically consider the holdings of say, EPF and PNB, as strategic stakes. It will deem these shares as part of the free float if it believes that the shares are held as mere investments.
This policy does help because there are certainly many instances when the government-linked funds play no part in the management of the listed companies. However, this does not address the fact that the government and the government-linked funds collectively hold so many of the top-tier companies' shares.
To sell or not to sell
The solution that comes immediately to mind is that the government-owned vehicles and government-linked institutions should lower their stakes, either by disposing of their shares or diluting their holdings by bringing in other shareholders.
There are indications that such an idea has long been mulled over. Tenaga's sale of Guaranteed Exchangeable Bonds, a convertible debt issue, last year was, in part, a step to push up its free float.
Analysts say the idea is commendable although the effect is rather slight. Unfortunately, the other listed companies have not done anything similar.
FPLC's Najmuddin believes that the recent proposal to merge government-linked companies within the same sector is another move to improve the free float situation.
However, it is perhaps too drastic to ask the government-linked funds to sell their shares for the sake of increasing the free float.
After all, the funds are only doing what they have been set up to do – to make investments, on behalf of contributors, that offer security and good returns.
At a time when EPF is under fire for its dwindling dividends, it flies in the face of logic to expect the provident fund to sell a few million blue chip shares so that other investors can get a share of the companies' earnings.
Says a capital market observer, “I don't believe that the government-linked funds have such big stakes in the large-cap companies because the government wants to control these companies.
“It may simply be that the funds want to keep enjoying the returns from holding the shares.”
Indeed, if the funds were to partially pull out of the large-cap companies, where should they put the money?
According to Toh of CIMB Securities, the equity holdings of domestic funds increased by RM9 billion in 2002. That was equivalent to 3 per cent of the KLSE's market capitalisation.
“This growth will likely accelerate, given past trends. So, for the big investors, like EPF and PNB, the new money has to be invested somewhere. Putting it in blue chips or well-known names would be the safest,” he says.
As the CEO of the local asset management company points out, investing in the second liners or small caps, no matter how attractive they are, can be riskier. It does not help either that these companies' share liquidity is usually even lower.
“We're hesitant to take positions in these companies because we fear that it may be hard to get out should things go wrong. We may be stuck with the shares for years,” he says.
Time to act
These are all valid points, but there is still no doubt that for the KLSE to be more attractive to foreign investors, the free float issue has to be addressed. And the government has to play the pivotal role, both as a regulator and as the entity that ultimately controls major stakes in the large-cap companies.
Analysts say a 40 to 50 per cent free float level should be the target. Says a research head at a local investment house,
“There's always the fear that share prices will be more volatile when there's a higher free float. But we have to accept that. That's the nature of a free market.”
It is interesting that the economic stimulus package announced by Prime Minister Datuk Seri Dr Mahathir Mohamad on Wednesday included measures to increase foreign equity participation in Malaysia.
These include a relaxation on foreign shareholding in listed companies in sectors such as banking and telecommunications.
There is a possibility that this may lead to MSCI increasing Malaysia's weighting in its indices since this development may affect Malaysia's free float as defined by MSCI.
ABN AMRO head of research Chehan Perera says : “Regional indices are based on available foreign free float.
“So, if the limits on foreign shareholdings are liberalised, foreign free float could also rise, thus possible leaving room for an upward revision in Malaysia's rating.”
However, market-watchers point out that this depends on whether there is a demand by foreigners to hold more equity than the current limit.
Some market-watchers are convinced that the low free float is an issue largely because the KLSE is still hampered by weak sentiments.
“The lack of foreign interest is not all down to share liquidity. If the Malaysian equity market is back in favour, the low free float may not be that big an issue,” says an industry insider.
The argument here is that the substantial shareholders are not releasing shares because there is not strong enough a demand. Or to put in another way, the shareholders will not get a good price for their shares if they sell now.
Najmuddin of FPLC, who is also president of the Malaysian Institute of Corporate Governance, thinks that another way of correcting the problem is to improve the investment community's perception of corporate governance in Malaysia.
He says: “There's no clear-cut solution. We need time to build up confidence in our stock market. First, we have to ensure that our companies are well-run and that they practice good corporate governance.”
This is certainly a problem that cannot be resolved in haste, but judging by the lack of development on this front over the last three years, some sense of urgency may now be necessary.