Sri Lanka can effectively use capital markets as a pillar of economic development, if understood and used properly. The lack of knowledge of capital markets, and how it can contribute to harnessing long term capital needed for financing of development, ranging from building Infrastructure to growing manufacturing and services businesses, have been a bottleneck to use the capital market as an effective tool for development in Sri Lanka,” CEO NDB Wealth Management Ltd, Prabodha Samarasekera said in an interview.
Samarasekera has been involved in and with the capital market sector for nearly three decades and has contributed immensely to the growth of NDB’s wealth management business, making NDB Wealth the number one fund management company in Sri Lanka.
However, Samarasekera adds that the changes initiated almost 30 years ago is what’s being driving the capital markets of Sri Lanka. The capital market was energized in the early 1990s with funds flowing in to emerging markets and was complimented by the government appointed “Banking Commission” recommendations which included reforms to develop financial services including capital markets in the country. Thirty years on, it may be an opportune time to re-think the role of the financial services industry including capital markets. The financial service providers need to work with the government policy makers and industries to develop a new vision or a template which Sri Lanka should adopt prioritizing the island’s development needs.
In this interview Samarasekera explains how his company was able to build a successful wealth management business amidst a difficult environment and suggests some points for the financial services sector development in the country.
Excerpts:
Q: When we mention the word ‘capital market’ in Sri Lanka, people commonly think about the ‘stock market’ only. Why is it?
A: First, we need to understand what capital markets are and how it can be harnessed to develop the country. What Sri Lanka needs now are funds to finance its development, be it the government or businesses? And capital markets can be used effectively to achieve this. However, lack of knowledge and sticking to what you know or in your comfort zone has been a barrier to exploiting capital markets for growth. Also many in Sri Lanka associate capital markets, with the stock market, which is only one part of a larger universe. So a capital market include not only stocks, but it can include bonds and various other forms of capital raising instruments. That’s the part I think most people have missed.
In Sri Lanka, the government treasuries market is very large and is over Rs.7 trillion in comparison to the Rs. 2 trillion stock market. Moreover, the government treasuries market is very important because it sets the base for pricing of all other assets in the country. Therefore, the Government securities market needs to be carefully developed and be made efficient and transparent for the capital markets to work well.
Q: How has the fund management industry evolved in Sri Lanka over the last three decades?
A: When NDB took over this company, it was just a unit of an Insurance company. NDB bought the company with the intention of making it a true wealth management firm, and with a view to developing a strong external client base.
Today the company is fully owned by NDB Capital, which in turn is 100% owned by the NDB Bank. Therefore, “NDB Wealth” is our brand which represents our parent and the business we are in.
In terms of our wealth management business, we have two services – the mutual fund or the unit trust business as it is called in Sri Lanka and the discretionary portfolio management business.
The discretionary portfolio management, for people who do not understand the terminology, is having a separately managed account for clients, be it a high net worth individual or large corporate like an insurance firm or a provident fund. Discretionary clients who entrust the management of their funds to NDB Wealth, give specific guidelines as to how their funds should be managed. This is done by defining the purpose or the ultimate goal for setting up the fund, and then defining the risks that are acceptable in trying to achieve the defined goal.
As for mutual funds or a unit trusts, we pool money from many clients into buckets or a fund and manage that fund to achieve a well-defined common goal, within a specified set of risks defined for that fund. So, mutual funds are a more mass market product, whereas discretionary funds are very focused on a single client, with large amount of funds.
In terms of clients- we have two different segments of clients, and they are institutions and individuals. An individual client can be a high net worth individual (HNWI) who will have a very specific discretionary portfolio or a smaller client who will pool his money for management with others through mutual fund. The advantage in a pooled fund or a mutual fund is that, investors with small amounts of money can avail themselves of the benefits of an investor with a large amount of money. This helps democratize building wealth. However, we see even very large institutions using mutual funds, especially money market funds, to manage their short term cash needs.
Now, if you go back to the Unit Trust market in Sri Lanka; for a long time the industry struggled to take off, even with the tax breaks it had. The reason for this I feel is that the industry started by offering the wrong product first. In my view the unit trusts in Sri Lanka should have started by introducing the concept of “Money Market Funds” first, and not with Equity Funds as was done in the early 1990’s. My reasoning is because the interest rates paid on Government of Sri Lanka Treasury bills were around 18% - 20% per annum in the early 90’s, which was a very good return for investors with very little risk. Also, the later surveys we deployed very clearly indicated that the Sri Lankan investor/saver prefers safety and liquidity over risky long term investments, which is what investments in the stock market are. So the mistake the mutual fund industry made then was to offer higher risk equity funds as opposed to low risk money market funds during a period of high interest rates.
At that time the banks were the biggest beneficiary of risk free, high interest paying government securities. If you remember, bank interest rate offered on deposits were below the interest rates offered on very safe government securities. In fact, this interest rate anomaly prevailed until about 2007, where the government treasury bill rate or the risk free interest rate, was higher than the interest rates offered by riskier bank deposits. So essentially what Sri Lankan banks were doing was taking your money and lending it to the government at a higher rate. In around 2007 this market anomaly started to change where the market began to price risk properly. This in my view was a huge mind set change. And no one had innovated to offer a suitable product to rectify the anomaly.
Mutual fund industry recognized some of the market anomalies and innovated to introduce money market funds. Since then the mutual fund industry has shown remarkable growth.
Q: Why do you think Sri Lankans are risk averse?
A: Having done some surveys with various professional research institutions, we found out that Sri Lanka is a fairly risk averse market due to several reasons. One of the main reasons is Sri Lanka’s policy inconsistency where policies have fluctuated regularly making investment decisions difficult and risky. Added to that the 30-year war and various other insurgencies; did not help establishing a stable operating environment for the government or the businesses.
Only during the last 10 years, we managed to have a country with relative stability. However what is important to remember is that all of us live through our experiences; we extrapolate our past experiences to the future. It usually takes a long time to change behavior. Therefore, the volatility, and possible risks of the past are still in the minds of the general population. My analysis is that the Sri Lankan investor has become very conservative and may remain a conservative in to the foreseeable future. Therefore, we need to devise ways to overcome this phenomenon by teaching people on how to take risks before introducing them to risky products. An example was the introduction of the first securitized paper in the mid 1990s for a leasing company. The issue was guaranteed by a multilateral agency in order to provide confidence. Now structured or asset backed paper is very common and are used by various organization without any sort of guarantees.
At NDB Wealth, we decided that this change needs to be gradual. That’s when the idea for money market funds was born as money funds are very similar to bank savings accounts and most people were familiar with how a savings account operated.
Q: How did NDB Wealth innovate products to take advantage of the market anomalies?
A: We decided to innovate by introducing money market funds to Sri Lanka. We created the two funds; one a government securities based money market fund called “NDB Wealth Money Fund” and another corporate debt based money market fund called “NDB wealth Money Plus Fund”. That was the beginning of the takeoff of the mutual fund industry, and NDB Wealth’s mutual fund business. Pre money market funds, the unit trust industry was at about LKR. 15 billion. Post introduction of money market funds the mutual fund industry funds very quickly reached LKR.130 billion. That showed that the industry had identified the right product and people were beginning to realize the value delivered through mutual funds. Given that NDB Wealth was the first company to introduce the money market concept, it has done very well. NDB Wealth’s mutual funds have grown from LKR. 0.65 Billion to around LKR 55 billion, almost 85 times.
“NDB Wealth Money Plus” fund on the one hand is like fixed deposits with similar returns; but on the other hand operates like a savings account where you can deposit or withdraw money at any time. As a Sri Lankan company I’m really proud to say even in the US withdrawing money out of money market funds usually takes two days. But in Sri Lanka we have got it down to same day or next day.
Q: How did NDB Wealth become Sri Lanka’s largest fund manager?
A: First, we built a capable young team with the required expertise. Then we gave them the freedom to perform. Second, we built a team of well-trained advisors, who were trained to think of the client first and not profits. Third, we continuously introduced technology to improve service and operational efficiency.
Q: The Company has heavily invested in technology over the years. How does the technology contribute to the growth of this sector?
A: We have invested heavily on technology to provide a high level of service to clients, than increasing the number of staff and building a branch network. We will be infusing more technology and will reach out to more people in the near future. We have a very clearly defined process. Everything is system driven from the time you open an account to the time you withdraw money. In fact we do not deal in cash; but every client needs to have a bank account to open a wealth management account. It can be with any bank. If a client prefers to have an account with the NDB Bank we can very easily do it for them.
For clients with accounts with the NDB bank, we can offer seamless banking facilities such as overdrafts and credit cards. So once a client’s money is deposited with NDB Wealth, and when withdraws are requested, the withdrawal will be transferred directly to the client nominated bank account. The system here is very transparent- all deposits and withdrawals are informed to the client through email/SMS services. This also prevents fraudulent transactions.
On an average, of the brand new accounts that are opened within the unit trust industry, each month, NDB Wealth enjoys a share of around 70 to 75% and around 90% of the new deposits.
Q: How important is technology for financial markets development?
A: The financial services sector operating costs are high and returns to shareholders have continuously reduced over the years. To improve service efficiency and returns to shareholders, the productivity needs to improve.
Introduction or adoption of new technology, and the timely approval for the use of new technology by regulators need to be promoted. And new technology not only needs to be used for improving productivity but also for product innovation and service improvement. For example, an electronic National ID card system will help make the customer acquisition and onboarding process easy, efficient and cost effective.
Q: From your point of view, what are the best options for savers and investors today given that the interest rates are low?
A: Savings can happen in many ways; stocks, bonds, gold, property, foreign currency etc. The most common options, even today, in Sri Lanka, are savings accounts and fixed deposits. Now that there’s a new product called the “money market fund”, that is another attractive option. We see that money market funds are becoming very popular now, though it is still at the very early stages of its growth. I believe it will become a main stream product in Sri Lanka, like it is in many other countries. On average, the top 15 banks in Sri Lanka pays around 3% interest on a savings account whereas the “NDB Wealth Money Plus Fund” has a current yield of around 9% which is almost three times higher than most bank savings accounts.
What does that mean? Most of us are on fixed salaries. So with higher rates from a money market fund, the amount of money that you need to save to build your wealth is a lot less, and so is the stress of having to compromise between saving and managing your expenses. If you’re earning around three times more naturally your stress of deciding between whether to save or spend is reduced. This is an important concept that people need to understand. Given that you earn a higher income means you can save less but go on to achieve the same wealth target. Moreover, this will free up cash to spend on your family’s expenses.
I would say that NDB Wealth manages its clients’ money conservatively; which means we are focused on managing risk while making sure the returns are satisfactory.
Q: How do we decide about investing in stocks versus money market?
A: So stocks are a different risk category. It’s a different asset class. In my view stocks are a long-term investment or should be viewed so. Investing in stocks in comparison to saving with a money market fund are not comparable as they are very different in terms of potential returns and associated risks. Stocks are risky because the underlying businesses representing the stocks are subject to higher risks. For example, with the current Covid 19 pandemic, businesses such as hotels may suffer loss of income and in turn may have an impact on the stock price. So you need to be mindful that as much as you can make very good returns, in stocks, you can lose all or part of your capital.
In my view, when building your wealth, stocks should be the third option you should consider. First, people need to be in money market funds and start building capital; then consider investing in a bond portfolio or property and third, when you have built enough capital, invest in stocks. You will know you are ready for the stock market when you invest in stocks and then not having to worry about meeting your regular expenses.
NDB Wealth offers bond and stock funds in addition to the popular money market funds. For example the NDB Wealth’s own Government of Sri Lanka bond fund, the “NDB Wealth Gilt Edged Fund”, gave a 19.5% return during the year 2019.
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