Foreign investors missing during run-up, hidden gems to be found

THE Malaysian share market has escalated 51% from a trough of 836 in mid-March this year. The benchmark FTSE Bursa Malaysia KLCI or FBM KLCI is lingering at an 18-month high, albeit 17% below the historical peak of 1,524 points achieved in mid-January 2008.

Yet, foreign investors had barely made their presence felt during the run-up, and were glaringly missing from the scene.

That is one reason why our local bourse performance had been lagging its regional peers — Malaysian stocks probably benefited less from rising liquidity flows that had lifted global equities since March this year (Figure 1).





Missing in action
There could be little foreign money in Malaysian equities at the moment, as revealed by a sample of anecdotal evidences:

(a) Net portfolio investment of shares and corporate securities has shown a consistent outflow for nine consecutive quarters, with a cumulative deficit amount of RM83.4 billion since 3Q07 (Figure 2). This implies more selling than buying of Malaysian stocks during the period.
(b) Foreign participation (expressed as a percentage of total trading value on the Malaysian stock exchange) has dropped from 42% in the whole of 2008 to 25% in the first nine months of this year, suggesting foreign investors had been inactive so far (Figure 3).
(c) Foreign brokers' market share is also declining. Of the six licensed foreign brokers operating directly in Malaysia (which are more commonly used by overseas fund managers to trade equities in this country), only three names appeared inside the top 15 brokers' ranking, with a combined market share of 11% of total trading value for January-October 2009. This compares with five foreign broking companies on the list that together accounted for 22% market share between January and December 2008.
(d) Foreign ownership — standing at 21% of overall market capitalisation as of September 2009 — is at its lowest in five years (Figure 4). This means there is a relatively small presence of foreign money in Malaysian equities at this juncture.







Foreign absence explained
To be sure, foreign investors could have been underweighting Malaysia as an investment destination in recent years for two primary reasons:

(a) Even though the domestic market price-to-earnings (P/E) valuation is undemanding by historical standards, viewed together with slower earnings growth prospects, it seems less appealing relative to its peers in the region. This was already the situation before the market run-up, and remains the case currently (Figure 5).
(b) The relatively small size of the Malaysian bourse (market capitalisation of US$287 billion or RM972.9 billion) and its low turnover velocity (39%) versus other regional exchanges (Figure 6a and Figure 6b) caused our market to be marginalised as international fund managers could afford to give Malaysia a miss with minimal risk of broad portfolio underperformance.





Revisiting Malaysia
Admittedly, Malaysian equities still appear less compelling in the Asian context based on valuation. But what could change is that Malaysia's appeal as a defensive low-beta market might whet investors' appetite to diversify country allocation risks, especially if regional equities become increasingly risky as volatility intensifies going forward.

Also, statistics released last week could be a sign that foreign selling is tapering off, as net portfolio investment of shares and corporate securities registered a narrower outflow of RM4.5 billion in 3Q09, its smallest deficit since 1Q08 (Figure 2).

An added incentive for making a gradual tactical shift to investing in Malaysian shares is the opportunity to ride on a strengthening ringgit. DBS economist predicts the ringgit will appreciate vis-à-vis the US dollar to RM3.24 (up 4.5%) by 4Q10. Meanwhile, this currency – notwithstanding its individual strength against the US dollar — has been trailing a few other currencies.

At a time when several countries (such as South Korea, Indonesia and India) have attempted recently to "talk down" their respective currencies by signalling the possible imposition of capital controls (to limit the influx of hot money and prevent any sudden reversal that could cause exchange rate instability), the ringgit might be seen as less vulnerable to an abrupt sell-off given its relative underperformance so far.

Stock picks
Scattered gems on the ground. More excitingly, from a bottom-up perspective, there are fundamentally undervalued stocks that were once favourites of foreign investors, but are now underowned by them.

The top five on our buy list with foreign shareholdings grossly below their recent highs are CIMB (33% foreign ownership as of end-June 2009 vs a peak of 54%), IJM Corporation (34% vs 62%), MRCB (19% vs 44%), S P Setia (28% vs 56%) and Tenaga (11% vs 28%). Their financial and valuation data are shown below.

(Note: The latest available foreign shareholdings record is as at June 30, 2009, which was five months ago. We believe the existing foreign shareholding levels remain more or less similar based on our random checks with selected companies recently as well as macro indicators which signalled more foreign selling since then).

More interesting buy ideas. Going down the list, our ground checks revealed additional counters currently rated buy by our analysts that could increasingly gain traction among foreign investors again.

They include Gamuda (45% foreign shareholding in June 2009), Genting (44%), Genting Malaysia (33%), Hong Leong Bank (7%), Proton (16%), Public Bank (25%) and RHB Capital (5%).

What else? On a separate note, for reference purposes, we compiled a list of stocks that our research team is less bullish about, but with their foreign shareholdings levels also much lower than their preceding highs