Foreigners good for the market

• Due to continued stream of buying and selling, prices of specific counters reflect market value

The stock market supplies information about the profitability of an investment. As a result, a well functioning securities exchange may induce a high level of investment because it helps identify fundable projects.

The capital market also affects the quality of investment or the allocation of capital by channelling funds to the most profitable investment activities.

This enhances innovation and competition as cash deficit firms compete for scarce capital resources.

An expanding capital market, with increasing liquidity, offers more opportunities for risk sharing and investment diversification, which further lowers the cost of equity finance.

Put another way, an increase in liquidity increases the ease with which an investor is able to react to market information and exercise his/her right to transfer capital from one investment and into another.

Investors being risk averse place a premium on liquid markets and therefore will be more willing to allocate more capital to such markets.

Trading in the equity markets has significantly increased in 2010, with the period till the March 23 witnessing equity turnover worth Sh6.04 billion, representing a 44 per cent increase over February.

Foreign participation been significant thus far – 33.74 per cent, 72.17 per cent, 50.59 per cent and 51.32 per cent of total market turnover for December 2009, January, February and part of March 2010 respectively.

Indeed, foreign turnover has increased from Sh2.13 billion in February to Sh3.1 billion in March so far. A total of 5,791 deals were for purchases compared to 870 deals for sales by foreigners.

According to statistics, since February 2009, we have recorded more foreign purchases than sales on increasing volumes, indicative of a net inflow position for a period of slightly over one year.

Foreign capital plays an essential role in the development of equity capital markets in the short to medium term. Foreign investors add to the much needed liquidity in a market through ensuring vibrancy at the specific counter levels.

This ideally means that at any given time, because of a continued stream of buying and selling, the prices of specific equity counters reflect the current market value.

Increased participation of foreign investors in the stock market is testament to the effective nature of the market in its ability to attract foreign capital.

It shows that our markets are easy to access and are efficient. Further, this participation allows for further external development of the market through the attraction of sophisticated investors, who can then drive the product offering available.

The downside is the threat of capital flight, which we experienced in the period running from August 2008 until December 2008 in the wake of the global crisis. This is a vulnerability that a lot of frontier markets experience.

However, this can be mitigated by enhancing transparency, which is based on enhanced corporate disclosure, reliable official macroeconomic data and effective running of the macroeconomic policy.

This would equip investors to look beyond the short-term crisis and be reassured by the long term fundamentals.

Accessing capital

What of ownership? The trend by foreign investors is that of maximisation of growth opportunities. They seek to tap into the competitive returns in our markets, which can range between 10 per cent to 50 per cent or more owing to the fact that our market is nascent.

In fact, out of the 55 listed companies on the bourse, only 12 companies have significant foreign shareholding (less than 30 per cent), and half of these companies are multinational subsidiaries. Majority of the companies have local shareholders.

Capital markets are increasingly becoming globalised and there is a constant challenge to represent an attractive platform for accessing capital. The ability of a bourse to tap into the international spheres for capital acquisition is a positive trait and it would be in our interest to facilitate this through increasing the free float available for purchase in the secondary market.

However, it is important to realise that the long-term stability of the domestic financial market is better assured if there is larger proportion of domestic portfolio flows relative to foreign portfolio flows.

Mr Mwangi is the Chief Executive of the Nairobi Stock Exchange