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CONFIDENTIAL AND PROPRIETARY Any use of this material without specific permission of Candor is strictly prohibited

The Sri Lanka Capital Market: Good Governance for New Opportunities

Ravi Abeysuriya, CFA Group Director / CEO Candor Group

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Domestic Investor Participation Rate in the Sri Lankan Stock Market is One of the Lowest

Source: Investor Protection, Equity Returns, and Financial Globalization, JOURNAL OF FINANCIAL AND QUANTITATIVE ANALYSIS

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The Industry has lost Investor Trust

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We Must Restore “Trust” in our Capital Market

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Asset Management is Least Trusted

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Factors Contributing to Lack of Trust

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Ethical Issues Facing Global Markets

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The Cost of Failure of Trust - Miss out on the “The Power of investing”

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Firm level Actions Most Needed to Improve Investor Trust

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Trust Attributes

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CFA Institute Code of Ethics & Standards of Professional Conduct

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CFA Institute Asset Manager Code

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CFA Institute Integrity List

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CFA Institute Statement of Investor Rights

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Companies/Issuers Willing to disclose &

avert insider trading Corporate governance Financial transparency &

avoid accounting manipulation

Investors Have trust & confidence in

the market Are financially literate Have a long term investing

perspective Have strong & professional

institutional investor base

Quality of governance, Pro Growth Policy Reform

Greater choice of instruments to manage risks Expansion of institutional investor base Encouragement for large companies and state

institutions to list Laws that safeguard property rights

Intermediaries Adopt a Code of Ethics Serve the best interest

of their clients “High quality” – value

reputation, ethics & professionalism

Robust Regulation Market needs to be fair & orderly Enforcement and sanctions that

instill confidence in the market Benchmarked against global

standards

Integrity of the market & its participants and market liquidity

Key drivers required to foster growth of the stock market

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Reform Equals Opportunity for the Sri Lanka Capital Market

• Capital Market is under-owned by domestic investors versus its emerging market peers

• Industry players willingness to act in a professional & ethical manner for the long term future of the industry

• Governance reforms & improvement in capital market regulation, demutualization of CSE, DVP & CCP, National Payment Gateway, e-KYC

• Pension reform will increase long term saving and “institution capital” • Sri Lanka is the gateway to India – India will become world’s largest economy

and will have the largest population, Foreign investors will continue to surge to India as reforms by Prime Minister Narendra Modi take hold and investors search for growth (India stock up more than 20% last year)

• The magnitude of the impact depends on the commitment to reform by all stake holders

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Opportunity to establish a facility to check out the integrity of RIAs & Market Intermediaries

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Opportunity to increase the domestic stock market participation rate

• Growing Body of empirical evidence showing that weak investor protection is negatively related to stock returns

• Equity returns are lower in weak investor protection countries as stock prices do not reflect the demand from foreign & local portfolio investors

• Wealthy investors have an incentive to become controlling shareholders as firms cash flows accrue largely to controlling shareholders

• Price of weak corporate governance stocks is not low enough due to high demand from controlling shareholders

• Foreign & local portfolio investors avoid investing in countries where the domestic stock markets display weak governance

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Opportunity for inclusion in MSCI Emerging Market Index

• Being included in the MSCI EM Index has much larger implications for Sri Lanka • Convincing evidence of positive price impact upon inclusion • “Radar Screen Effect” – attract more distant investors and hence require lower

expected returns • Stocks included in the MSCI EM get increasingly integrated with the world

markets which means there is increased risk sharing between local and foreign investors

• Listing two large and profitable state institutions and establishing a public float of over 20% could be a major catalyst to attract foreign investors to our capital market

• USD 9.5 trillion of assets are benchmarked to MSCI indexes - When Sri Lanka is in the index, MSCI Emerging Market Index tracker funds will be required to invest in Sri Lanka as they need to replicate the index.

MSCI EM Index captures large and mid cap representation across 23 EM countries with 836 constituents, Index covers approximately 85% of the free float adjusted market capitalization in each country Countries include: Brazil, Chile, China, Columbia, Czech Republic, Egypt, Greece, Hungry, India, Indonesia, Korea, Malaysia, Mexico, Peru, Philippines, Poland, Russia, Qatar, South Africa, Taiwan, Thailand, Turkey, UAE

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More opportunity for long-term saving and investment propositions

• Sri Lanka has one of the fasted aging populations

• Asia is replacing Europe as home to the highest population of middle-class people

• Global investable assets for the asset management industry are expected to increase to US $100 trillion by 2020 with an estimated compound growth rate of over 6% per annum higher than global GDP growth

• The need of the hour is fostering a robust asset management and pension fund industry

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CSE Returns & Volatility

INDEX 1 YR RETURN (%) 3 YR RETURN (%) 5 YR RETURN (%)

Period Annualized SD* Period

Annualized

SD Period Annualized SD

ASPI 14.6 16.0 3.5 48.6 14.5 15.4 69.4 11.3 14.8

S&P 20 17.3 19.0 3.8 44.2 13.3 13.5 67.8 11.1 17.6

MSCI Emerging 1.9 2.1 4.0 15.6 5.1 18.8 13.1 2.5 18.1

Hang Seng 21.8 24.1 5.0 51.0 15.2 20.1 42.3 7.4 20.2

S&P BSE 500 Index 16.2 17.8 5.2 70.3 20.1 26.2 57.7 9.7 32.4

FTSE Malaysia -2.4 -2.4 3.0 15.0 4.9 19.9 41.5 7.3 17.8

Jakarta Composite 3.9 4.2 3.2 32.7 10.2 23.0 81.9 12.9 25.1

Candor Recommendations* 13.1 220.5 1.7

*Candor’s recommended stocks are included for a holding period of 2 to 3 months & annualized return is an average value of all the annualized returns of respective recommendations * SD – Monthly range for 1 YR volatility & Yearly range for 3YR & 5YR Volatility

Source: Bloomberg, Candor

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ASPI vs. Other Regional Markets – 5 yr Return & Volatility

0

5

10

15

20

25

30

35

ASPI MSCI Emerging Hang Seng S&P BSE 500 Index FTSE Malaysia Jakarta Composite

5YR Annualized Return Standard Deviation Source: Bloomberg

%

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How Investors miss out on the Power of Investing Real Stock Market Returns vs. Real Savings Account Return

-

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

45,000

1985

1986

1987

1988

1989

1990

1990

1991

1992

1993

1994

1995

1995

1996

1997

1998

1999

2000

2000

2001

2002

2003

2004

2005

2005

2006

2007

2008

2009

2010

2010

2011

2012

2013

2014

2015

10,000

15,445

34,049

29,730

18,569

8,119

22,023

10,625

42,679

36,614

30,985

35,421

2,379

Real Stock Mkt. Return Real Savings A/c Return

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Conclusion

Good Governance and Ethics is critical to market development and can provide grater opportunities for investors and the society at large

Bad Governance Good Governance

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0%

50%

100%

150%

200%

250%

300%

350%

400% Ju

n-09

Au

g-09

O

ct-0

9 De

c-09

Fe

b-10

Ap

r-10

Jun-

10

Aug-

10

Oct

-10

Dec-

10

Feb-

11

Apr-1

1 Ju

n-11

Au

g-11

O

ct-1

1 De

c-11

Fe

b-12

Ap

r-12

Jun-

12

Aug-

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Oct

-12

Dec-

12

Feb-

13

Apr-1

3 Ju

n-13

Au

g-13

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ct-1

3 De

c-13

Fe

b-14

Ap

r-14

Jun-

14

Aug-

14

Oct

-14

Dec-

14

Feb-

15

CSEALL vs. Global indices: June 2009 - March 2015

CSEALL

DJI

FTSE 100

Straits Times

MSCI Emerging

S&P 500

Hang Seng

MSCI World

Source: Bloomberg

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New rules would make advisers put investors first

http://www.usatoday.com/story/money/2015/02/23/new-rules-financial-advisers/23878905/