02 February 2009

The capital market comprises many investment instruments and securities, and throughout the past couple of decades, the wizards of finance and trading regularly conjure up new instruments.

Many of these investment instruments are based on speculation and leverage. Speculation is when you invest on price movement. Leveraging is amplifying your investment with options. Often the investment is based on consensus whereby the collective basket of assets determines how the investment instrument will perform.

The underlying criterion for these sophisticated instruments is the creation of liquidity. Usually multiple markets of the asset class has to be created that makes the instruments liquid and marketable.

For instance, investing in currencies, commodities and even gold and oil is not exactly based on demand for the asset but on the demand for the option instrument. Asset Managers create multiple options which give each option holder the right but not the obligation to purchase the asset. Investing in futures, derivatives, contracts for difference, indexes, structured products, hedge funds and even secondary mortgages are other examples of speculative and leveraged investments.

The problem with these types of investment is that they introduce humongous risk levels to the average investor. Nonetheless, some investors are happy with the opportunity to amplify their risk through leveraging because they seek higher potential returns.

Investors are generally quite aware of the said types of investment instruments. Although they may not understand them, there is a lot of marketing and promotion that goes on about these instruments. Analysts and traders are all over them. In a sense the ‘investor relations’ of such investment products are quite sophisticated and a lot of information dissemination and disclosure occurs on it.

But now the tables have turned. Many of the instruments have collapsed or are surviving on a lifeline. In addition, the global financial market fallout is causing credit flow to businesses to be choked and companies eventually take the hit. Global trade is slowing down or stagnating. Downward spiralling equity valuations are also greatly affecting businesses’ capital sources.

The IR officer at these companies is now at a crossroads. Some have got their hands full trying to explain their issues and corporate sustainability. Others have chosen, rightly or otherwise, to lie low.

Arguably what is making things really bad in this economic crisis is the shattered investor confidence. Investor confidence is a necessary component of any recovery effort. However, a lot of trust has been lost.

Investors who are privy to sophisticated instruments and private wealth management are no longer confident of what’s real in the market, given that reality of the Madoff pyramid scheme. Retail investors have lost trust in investment banks and institutions that were supposed to be bastions of financial and investment management. Investors who are just learning about investing, including young investors, are quite turned off with the level of volatility and market making that goes on.

All this chaos may bring about the dawn of a new age of investor relations. Where investors go back to fundamentals and invest in real companies with real businesses. Where investors seek out information on companies, rather than speculative and leveraged investments. If so, companies will then see their valuations rise to justified levels. We hope IR professionals will embrace this imminent new regime of corporate disclosure, tempered by new spirit of regulation and fostered by responsible capital market participants.

Eddie Razak
February 2009

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