FOREIGN investors have pulled back a huge sum of $304m from the local equity market so far this year — a major bleeding. Accustomed to a fabulous average return of 32pc in the preceding three years, the investors are disappointed with having earned just a pittance of 3pc this year. Most blame foreign funds for their predicament.

Yet, a broker insisted that the “sentimental impact of the entry and exit of offshore investors is disproportionately enormous”.

This was proved in mid-March when the benchmark KSE-100 index was hammered on fears of a foreign sell-off. It actually turned out to be owing to the dissolution of a small US-based hedge fund, Everest Capital, with an exposure of just about $100m in Pakistani equities.

Take a look: Stock gurus optimistic about 2016

“Back-of-the-envelope calculations suggest that foreign investment in Pakistani equities is around $6bn,” said an equity strategist. “The KSE’s market capitalisation is currently $68bn, of which the free float is reckoned to be $24bn. Overseas investors hold over a quarter of that free float.”

Franklin Resources Inc., an American holding company, is the largest single foreign institutional investor in Pakistan with an equity portfolio of just under $1bn. Some other major international funds operating in the local equity market include the International General Insurance Co. Ltd, Lazard Limited, Schroder Investment Management and Goldman Sachs.

One market player pointed out that since the local bourse was an ‘all-cash market’ with no leverage and with the regulator strictly monitoring ‘in-house badla,’ the outflow of smart money had not sparked the kind of volatility seen in some other regional markets. He also pointed out that the local participants had managed to keep their sangfroid and absorbed all of the foreign selling.

The integration of the three stock exchanges into the Pakistan Stock Exchange and the entry of a foreign strategic investor can boost foreign fund managers’ morale, some optimists hope

But for all that, the episode this year has also set intelligent people at the market thinking. Is it fit and proper to let foreign investors tip the scales the way they want?

A well-known economist, however, asks the detractors to hold their horses. “Foreign portfolio investment is well known to be ‘hot money’ or ‘smart money,’ since it can exit as quickly as it enters.” It is, therefore, unfair to blame offshore investors when the overall market performance falls prey to foreign sell-off.

A ‘market strategy report for 2016’ released last Thursday by Topline Securities raises a disconcerting question: “how much more selling can come and how much lower can the market go?” And it guesstimated: “based on our judgment, in the worse case, a maximum of $400m of foreign selling can hit the market in 2016”.

Yet, a market player points out that foreign portfolio outflows from the KSE is not of its own making. During the year, ill-winds blew across the region. Most emerging and frontier markets had seen foreign investors stampede out of their bourses, taking mind-boggling sums with them to their homes in anticipation of a hike in interest rates in the US. Some market watchers also attribute the outflows from Pakistani equities to speculators in the Gulf.

Zubair Ghulamhussain, head of equity sales at Foundation Securities, identified one reason for the large outflow: “oil-rich nations are redeeming their sovereign funds to manage their budget deficits”.

Although the Pakistani market should technically qualify for larger overseas investment on the basis of its lower multiples and higher yields, there is another worrisome factor: the pressure on the rupee.

Many market participants say foreign investors also value ratings assigned by international agencies in allocating funds to emerging and frontier markets.

“The Pakistan market could see a rebound in 2016 with its likely inclusion in the emerging market from the frontier market by the MSCI, coupled with improving macros and a relatively stable political environment,” noted Topline Securities’ strategy paper.

Some other factors cited by brokers that might lure back foreign investors to the local market include high dividend yield and low valuations.

“Pakistan currently trades at 2016 price-to-earnings (p/e) multiple of 8.7 times, which is at an 8pc discount to the MSCI FM’s p/e of 9.5 times and a 32pc discount to its Asian peers,” said one analyst.

At a seminar last Thursday, KSE Managing Director Nadeem Naqvi said “the return on investment in the capital market has increased from 19pc to 23pc in the last five years”. He also asserted that “there was huge scope of further growth as a significant part of the economy was still undocumented and cash-based”.

Also, market-related developments like the integration of the three stock exchanges into the Pakistan Stock Exchange (PSX) and the entry of a foreign strategic investor could boost foreign fund managers’ morale, some optimists hope.

Published in Dawn, Business & Finance weekly, December 21st, 2015