Equity Research: the need for domestic expertise

The VN index has dropped from over 1000 to under 500 within few months! How could that happen? Actually, the right question is rather: over the period starting January 2006 until early 2007, the VN index has outperformed the regional index (MSCI Asia excluding Japan) by about 100%, are their any valid arguments to explain such a bullish trend? A market anomaly, most would say, unsurprisingly it was corrected.

From outside Vietnam, observers would probably put forward a contagion effect following the subprime crisis to explain such a dramatic drop of the Vietnamese market index. Vietnamese, however, know they also have to blame themselves. Now, the next question is: how to turn this crisis into an opportunity?

It is true that foreign direct investment jumped by nearly 70% to $20 billions last year, but the 8.5% growth of the Vietnamese economy last year was essentially driven by domestic demand largely fed with a lending spur. The price to pay today is inflation, calling for a tightening of the monetary policy, also raising the issue of the foreign exchange policy, to cool down an overheating economy. Victim of its eagerness to grow and catch up with its regional ASEAN partners, Vietnam may now have to accept a short term slowdown to remain on track for a brilliant future. As soon as this downward trend was anticipated, it was perceived as an alarm bell on the stock market, it was time for a severe correction.

No need to insist on the importance of an efficient capital market to guarantee a proper allocation of funds within a growing economy, as a corollary when “madness” prevails – and most admit it was the case on the stock market in Vietnam – the market does not fulfil this essential function. The broad diversification, some would say anarchic, of leading Vietnamese companies is a good example of mis-allocaltion of funds. The dramatic increase in money supply did not only boost demand for goods and services, resulting in inflation, but also for financial assets, feeding a bubble – a kind of inflation on paper – With easy money, local investors did not hesitate to borrow and speculate with the conviction of getting rich quickly by buying shares and selling them soon after. A common practice indeed, which the Vietnamese nevertheless seem to have favoured more than others, leading the VN index to unsustainable heights.

Among others, one possible explanation for this “stock market fever” probably lies in the well developed IT skills in Vietnam, and a natural enthusiasm for all its use. Numbers of online trading sites are now available, creating a sort of unformal OTC market, allowing for quick decisions at any time…and quick profits. Unfortunately, without proper regulatory oversight, this kind of environment is likely to become a realm of opportunistic behaviours where information asymmetry and manipulations dominate. However, it also reflects the lack of proper information available for investors due to a series of factors – such as the ambiguity of published financial information, the shortage of qualified auditors and financial analysts – In other words, due to a lack of it the market creates information – rumors are typical of that – to drive up prices and provide opportunities for speculative gains.

The stock market downturn is a good opportunity to put an end to that situation and take the necessary actions conducive to the efficiency objective. The remedies are well known: improved corporate governance, an appropriate regulatory framework, transparency. But, as far as transparency is concerned, providing investors with sufficient reliable information is not enough, one need also to reduce “bounded rationality” by enhancing the capacity of market players to analyze and use this information to take or recommend rational well documented decisions. So doing, one can expect stock prices to reflect corporate fundamentals rather than wishful thinking.

Equity research aims at providing this valuable information based on insightful analysis of market trends, industry prospects and performance of companies in comparison with their peer group in order to advise individual investors on most efficient strategies. Today in Vietnam, while the stock market is experiencing a new start after a tough correction, building a capability in the field of equity research is essential.

Equity research, though evolving, is based on a core of well accepted concepts, models and tools that global financial institutions tend to disseminate through their networks of branches, subsidiaries and partnerships. However, when applied to emerging markets one needs a domestic contribution to integrate all kinds of intangible elements that purely technical experts may not be able to identify. Providing adequate training programmes to meet this need for domestic expertise is therefore essential.

Dr. Professor Patrick GOUGEON is a member of the finance department of ESCP-EAP where he occupied several positions in the past, in France as well as abroad. In Asia in particular, as the Director of the School of Management at the Asian Institute of Technology (AIT, Bangkok, Thailand), then back to Paris as the Director of MBA programmes. He has also contributed to the development of various international programmes, such as recently the MEBF (Master in Economics of Banking and Finance, Hanoi & Hochiminh in Vietnam, an ESCP-EAP/Paris Dauphine joint programme) with the position of academic co-director. His research activities were first in the field of insurance and risk management. More recently he has also developed an expertise in the field of energy management with a particular focus on international project finance. Presently he is co-director of a specialised master in « energy management » launched in partnership with IFP school (Institut Français du Pétrôle) and BI Norwegian School of Management in Oslo