KUALA LUMPUR: Malaysian equity markets have come a long way but they have the potential to catch up to regional financial powerhouses like Singapore and Hong Kong, with Khazanah Nasional Bhd holding the key to closing the gap.

Matthew Song, from HSBC head of equity capital markets (Southeast Asia), explained at a roundtable yesterday that while the Malaysian markets are significantly behind Singapore and Hong Kong in terms of size, they are growing quickly and are heading in the right direction to one day catch up.

“Investors have come to realise that Malaysia has been very resilient to global events and has outperformed the (regional) market in recent times. I believe that it will become the next focus of foreign investors with its strong domestic consumption,” said Song.

To this end, he added that the local bourse will need to improve on liquidity, volume and free float, in which Khazanah will play a vital role.

“Institutional investors have been eyeing Malaysia and are just waiting to come in but they need more liquidity. Institutions will not buy a stake smaller than US$10 million (RM30.2 million). If they want to buy a US$20 million stake and trading volume is US$1 million a day, it’s going to take them 20 days to enter or exit a position,” said Song.

“To give some sense of where we are, Hong Kong’s daily trading volume averages about US$50 billion while Malaysia averages around US$5 billion a day.

Song believes Malaysia will be the next focus of foreign investors with its strong domestic consumption.

“To create this kind of liquidity, we need to increase the free float. I hope that Khazanah will follow through on its promise to pare down in holdings as this would open up the market to institutional investors,” he said.

The timing will be crucial as foreign investors and institutional investors have just begun recovering their risk appetites and will be looking to invest into emerging markets. As such, Malaysia could just catch the wave.

Song said Khazanah would likely sell its stakes to institutional investors via block trades or equity swaps which would be facilitated by banks.

Foreign investors and institutional players will be aiming to increase their exposure to the country as a defensive play due to the resilience of Malaysian stocks which can contribute to the low-beta component of their portfolios, he said.

Song said he expects the FBM KLCI to close 15% to 20% higher by the year-end.

“The KLCI is trading at a slight discount to historical valuations with lower price-to-earnings and price-to-book ratios compared to historical valuations,” said Song, who believes there is still some upside for the local bourse.

“We’ve seen valuations as high as 18 times earnings in the past. In fact, the market today, compared to several years ago is very different. Malaysia has not been on the radar screen of a lot of investors because the trading liquidity and volume in Malaysia was nowhere near as much as Singapore or Hong Kong,” he said.

“What we have seen in the past two years is the government privatising companies and paring down its stakes. If stocks begin trading about US$5 million to US$10 million a day it is definitely going to show up on the radar of institutional investors.”

Song also downplayed Malaysia’s lacklustre performance compared to the other Asian indices. The KLCI has only gained 3.32% year-to-date (y-t-d) compared with the MSCI Emerging Markets Index’s (MXEF) 16.29% growth y-t-d.

“We’ve only had six weeks of trading. If you look at India, it is coming up from a relatively low benchmark. As for the Hang Seng, it is a much more volatile market and it has seen a strong performance this year from where it ended down last year. On the other hand, Malaysia has been very stable in 2010 and 2011 and we expect Malaysia to be stable in 2012 as well,” he said.

On a broader note, Song said that the sentiment is generally very positive, much better than 4Q last year. Going forward there is a lot of upside for Asian markets, including the KLCI and the Jakarta stock exchange.

“I believe the main theme for 2012 will be investors looking for companies with earnings resilience, franchise values and strong balance sheets to capture acquisition opportunities.

“Sectors which will draw strong interest from investors are consumer retail, commodities and mining,” he added.

This article appeared in The Edge Financial Daily, February 22, 2012.