Throughout the world, institutional investors have played an increasing role in the development of the capital markets. During the last decade, institutional investors' direct investment in equity markets of the world has been gradually increasing.
These institutions are composed of insurance companies, pension funds, trust and mutual funds and indirectly banking institutions that have floated their own investment companies or investment funds.
According to reliable statistics available in the United Kingdom, Institutional shareholders accounted for 52.7% of UK ordinary shares as at the end of 1997 with a combined value of 669 billion pounds worth of market value at that time.
Out of this total holding, insurance companies amounted to almost a total of 290 billion pounds and it amounted to approximately 44% of the total institutional holding. This excludes individual ownership of trust units that in turn represented substantial amounts of investment portfolio. Rest of the world holders owned almost over 23% of the market value of the equity market representing almost 296 billion pounds of investment in equity markets.
These statistics illustrate that the direct shares ownership by individual investors accounts for less than one-sixth of the stock market valuation.
This analysis also provides an important indication that institutional investors are increasingly accumulating the stocks.
In economies where the equity markets are well disciplined and fully established, it is interesting to observe that direct investment in stock market by individuals is decreasing gradually and remains only one sixth of the total equity valuation.
We may conclude that the trend of equity investment is increasingly tilting towards institutional investments.
ABILITY TO CONTROL MARKETS: This objective is often achieved through a simple principle that the institutions are mostly investing on a long-term rather than short-term basis.
They have adequate cash resources available to intervene in the market whenever there is need to do so to shelter and protect their investments.
They are there to control the artificial bullish or bearish trends that are not backed by real technical or fundamental developments. Buying and selling securities to correct the artificial manoeuvring of the markets achieve this objective.
How far these institutional investors have achieved these objectives is evidenced by the size of the equity market in Western countries where funds are pouring in from all over the world that has enlarged its size.
The success of these Western markets lies in its stability, size and ability to correct itself through the activity of institutional investors.
Those economies, where there are no institutional investors or are very few or financially week due to insufficient liquidity at their disposal, have unstable equity markets and may show frequently more volatility.
If the market is volatile, there is every possibility that a big player may try to manoeuvre the market for its own advantage and small investors suffer heavily due to frequent unfavourable movements in the market.
REGULATING EQUITY MARKETS: Pakistan is a developing equity market struggling to survive since its independence. Gradually, the Securities and Exchange Commission of Pakistan is disciplining the market by introducing various corrective steps to stabilise the equity markets and to minimise the chances of intentional manipulation by the big players at the expense of the small investors.
The introduction of Central Depository System that has eased dealing and transfer of securities and has eliminated duplication and issue of bogus shares to the advantage of shareholders has been positive.
Carry Over Transaction (COT) system has been regulated and now replacing it with margin financing in a gradual manner starting from October this year and its completion is expected by the end of June next year.
Though there are concerns regarding this change, but generally it is considered a step forward to bring in stability and decrease volatility in the market.
MANAGEMENT AND CONFLICT OF INTEREST: The organisational structure of the stock exchange has been streamlined by separating the role of Chairman from the Chief Executive, who is called Managing Director.
The latter is appointed from outside the members thus providing a neutral person to make operational decisions and is responsible for managing the affairs on day-to-day basis.
The Chairman is elected from amongst the members of the stock exchange. It is arguable if this method of appointing Chairman meets the requirements of good corporate governance.
Under the present system, he is not a truly independent non-executive Chairman. Being Chairman, he would be having sufficient information, knowledge and contacts that may give him access to information that may create conflict of interest situation.
Currently, being a member of the Exchange; he is also involved in brokerage business. In addition to this, the brokerage houses normally maintain their own equity portfolios.
Under these circumstances, it is being strongly argued that there is serious conflict of interest in this appointment.
CHANGES DESIRED APPOINTMENT OF CHAIRMAN: It is desirable that the conflict of interest that currently exists within this appointment should be removed to ensure that the information obtained during the office of the Chairmanship is not used that may be termed "Insiders Information".
In practice it is possible to use confidential information for ones own benefit at the expense of others. So the remedy lies in the appointment of an independent non-executive Chairman whom do these members of the stock exchanges elect and who should not be a member of the Exchange and should not have any brokerage business of his own.
This method of appointment may ensure transparency, neutrality and effectiveness of this position and should restore the trust and confidence of not only the investors but also the government, as his position would be regarded as neutral and effective.
He would be in a position to discuss the matters with various Ministries and officials of the Securities and Exchange Commission of Pakistan with utmost confidence and strength.
The desired strength may not be available to a Chairman having his own personal interests involved in the negotiations and having prior knowledge of any changes that may result due to these negotiations. Use of this information may be detrimental to the others.
EXECUTIVE MANAGEMENT: The Managing Directors of these Stock Exchanges due to their sensitive role should not be appointed on any other boards or members of any Commission that may provide them information, use of which could be termed as conflict of interest.
The present Managing Director of Karachi Stock Exchange is a member of the Privatisation Commission. This creates a conflict of interest. He should have been barred from being a member of this commission or he should have resigned himself to maintain transparency and neutrality of this office.
CHANGE IN INVESTMENT PATTERN: Like the rest of the world, the investment trend in Pakistan has also changed during the last decade. The trend has moved from individual investing to institutional investing.
The precise and reliable statistics are not available for institutional investment in Pakistani equity markets. But with surplus liquidity soon after the 9/11 incidents, commercial banks have also entered the equity markets with the objective of investing and trading by utilising the idle liquidity and to improve its profitability.

COMMERCIAL BANKS: The objective of their investment strategies remains unclear. There is no doubt that they provided substantial funds to enlarge the depth of the market. If we review the financial results of these institutions, they have shown huge profits through stock market operations.
This gave better financial results for the banking institutions and they paid out handsome dividend to their shareholders that resulted in higher stock prices for their listed shares.
Direct investment by commercial banks in equity markets through their own equity portfolio is not regarded as a secure way of investing funds.
Normally it is done indirectly through investment companies that are owned by these banks. It may be argued that we need to change the present practice of direct investment in equity market by these banks to protect depositor's funds and the banks should concentrate on their core banking business rather than trading in equity market directly.
This should also ensure that the commercial banks are not investing in stock market operation on short-term basis and thereby avoiding any sudden selling that may be disastrous for the small investors.
Investment through subsidiary investment companies should provide a long-term view of investment and may further strengthen the capital markets.
This is an area, where State Bank of Pakistan has already brought in prudential regulations to streamline this activity and some of the corrective measures may also be under consideration.
CLOSE-ENDED MUTUAL FUNDS: Out of a total market capitalisation of approximately 1394 billion rupees as on 10th of September 2004, at present there are total of 19 close-end mutual funds listed on Karachi Stock Exchange with a combined capitalisation of rupees 15.99 billion, that amounts to 1.14% only of the total market capitalisation.
This reveals that small investors are shy to make their investments through mutual fund industry probably due to several reasons among them being that these mutual funds did not perform well in the past and were unable to provide strength to the to equity market.
Recently, these funds started restricting payment of cash dividends and resorted to issue of right and bonus shares that negates the basic principle of investment through mutual funds.
OPEN-ENDED FUND: Beside the mutual fund sector, open-ended mutual fund also exists in the market. The biggest being the fund managed by the National investment Trust, a State-owned management company with a total capitalisation of over 50 billion rupees.
That too has not been effective in disciplining the equity market because its main objective was the maximisation of profits and it was unable to protect, encourage or discipline the equity markets within the country.
It lacks fiduciary responsibility by directing and controlling the equity market by its planned intervention to minimise the manipulation by big players.
There is a need to redirect the strategy of this institution to absorb the market shocks through its prudent cash management and retention of some portion of profit to maintain consistent and evenly payouts.
INSURANCE AND OTHER SECTORS: In addition to the above institutions, the State-owned Pakistan Reinsurance Corporation, other insurance companies managed by the private sector, leasing and modaraba companies and the investment banks kept their presence in the equity market by maintaining their equity portfolios with the objective of earning capital gains and a regular flow of dividend income.
This sector provided strength to equity market as their portfolios were meant mainly for medium to long-term periods.
However, it seems that the sector lacks the proper guidance and has no long-term planning and strategy of investment.
Decisions to invest or disinvest are made purely by going with the wind to make short-term gains with a view to show capital gains as these are tax exempt and affects their bottom line of profitability.
That is considered harmful for the stability of the equity markets. This sector remains to be regulated.
BROKERAGE HOUSES: A reasonable portion of market capitalisation is also owned and maintained by large brokerage houses with the main objective of trading.
This portfolio is in addition to that kept in customer's group accounts of the brokerage houses that belong to their customers and the entire portfolio is at the disposal of these brokerage houses to use it for the purpose of manipulating the market.
INSTITUTIONAL ACTIVISM: Despite the shift in the pattern of investment recently, no visible change has been noticed in institutional activism to protect their rights as shareholders.
It is being discussed and argued that why these institutional investors have not been able to provide stability and strength to the market despite the fact that their share of the market has enlarged substantially compared with the past.
The answer may lie that they have not been able to successfully influence the market compared with the large brokerage houses that had years of experience in dealing with the equity markets.
Their investment strategies may not be effective and clear. They concentrated too much on earning quick money by involving themselves in active trading rather than investing.
These institutions went with the wind instead of going against the wind. They should have controlled the direction of the market by selling and buying to stop the manipulation of the market by these big brokerage houses that maintain their own investment portfolios.
They should have checked the manipulation when these brokerage houses act together to create bearish trends by selling heavily to pick up their choice of securities at substantial lower rates at the cost of small investors.
We have witnessed that the market is as volatile as it was before despite the fact that the institutions have bigger holding of equity market now if compared with the past.
It is normally witnessed that they do not intervene to stop the market falling with the result that on several occasions, the market dives more than 100 points without any major volume that gives a reflection that the fall of the market was manipulated.
This is exactly what happened soon after the new Prime Minister took office, when the market nose-dived almost 123 points with apparently no bad news. The market is still falling gradually with no apparent bad news.
The KSE index came down from 5300 to less than 5000 on September 15th 2004. This is a clear reflection of manipulation by individual brokerage houses. If the institutional investor steps in at the right time, there is no reason why the market collapses in such a big way incurring huge losses to small investors.
It should be remembered that loss of capitalisation of equity market is a national loss that belongs to the whole of Pakistan.
The money invested belongs to the banks, insurance companies, mutual funds, pension funds and small individual shareholders. Its loss without any valid reason should be viewed seriously.
MARKET MANIPULATION: The market manipulation is badly hurting the small investors and they are left at the mercy of these large brokerage houses. If we look at the history of the big brokerage houses, we arrive at the conclusion that these have developed and expanded rapidly during the last ten years.
In addition to the above mentioned availability of equity holding, the owners and their associates are in control of most of the large close-ended mutual funds.
They have entered into banking institutions and own some of the banks to fulfil their liquidity requirement that helps them to manipulate the market.
They have started taking over industrial units recently that speak for itself the type of reward they are reaping by manipulating the markets at the expense of small and institutional investor.
Their rapid expansion from brokerage business to owning mutual funds, banks and industries is being viewed as these objectives are being achieved in collusion with the inadequate rules and regulations that should have prevented the accumulation of equity trade in a few hands and minimisation of conflict of interest.
The ICP Mutual Funds were also privatised to these brokerage houses that further strengthened their grip over the equity market. It is being rumoured that the National Investment Trust will also be privatised in three parts to the owners of the members of stock exchanges that are running brokerage houses.
It seems surprising that we have not been able to devise any code of conduct that should ensure that the members of the exchange should not involve themselves in those activities that are considered as "against public interest".
REMOVING CONFLICT OF INTEREST: It is quiet clear that conflict of interest in the brokerage business is increasing every day.
It is arguable if these brokerage houses should be allowed to do trading of shares at their own account, they should be allowed to float mutual funds and manage these, they should be allowed to control banking operations directly or indirectly or they should be allowed to acquire controlling interest of industrial units that are listed on one of the stock exchanges of Pakistan.
It is surprising to see that the owners of these brokerage houses have been permitted to sit on different boards of listed companies and some of them have been associated with the privatisation commission to advise them in carrying out the privatisation of state owned enterprises.
Is it not a conflict of interest to acquire information that may be used for market manipulation? Is it not for the regulators to see that a decision to issue a GDR of any company known to a member of Stock exchange, operating an active brokerage house could be used in the manipulation of the market should be deemed "conflict of interest".
There is ample evidence that the information to privatise shares of OGDC, National Bank of Pakistan and shares of Sui Southern Gas Co Ltd was already known to these brokerage houses even before any announcement was made by the privatised commission in this regard. Can't we act prudently and maintain confidentiality and transparency? These issues are left with the regulators and the privatisation commission to respond.
We have not seen any activism from institutional investors to raise these issues with the regulators to ensure that transparency and issues relating to conflict of interest are satisfied to restore public confidence that is vital for market strength.
ROLE OF INSTITUTIONAL INVESTORS MARKET STABILITY: It seems too early to predict any real activism that may follow once the institutions organise themselves and become serious investors and follow guidelines that are being practised in Western countries.
With the current trend of investing through institutions, the role of these institutions has become more important not only in the development of the capital markets but also in the field of providing a more stable investing environment for individuals so that equity market becomes a relatively more stable institution that should provide better returns to small investors by keeping intact the principal capital and beating the inflation.
DEFINING INVESTMENT POLICIES: Each individual institutional investor may have its investment policy that is normally followed by the fund manager. But there seems to be a unanimous view that the institutions should make the equity markets more stable than it used to be in the past and the market should provide an environment to protect small investors' savings.
This may desire precise investment policies to be developed by these institutional investors.
FIDUCIARY ROLE: It is their fiduciary duty to ensure that they should be able to protect not only the interest of small investors but also their own investments in these securities.
It should be ensured that the companies improve their corporate governance record, they pay due attention to the desires of the shareholders and the companies make adequate profits to give a reasonable return on the investment of the shareholders and that the shareholders net worth increases.
They should be having a routine dialogue with the management's to resolve issues like payment of adequate dividends, maintaining a regular liaison with the shareholders, executive compensation packages and improving corporate governance beyond the boundaries of code of corporate governance and more importantly on the appointment of non-executive directors who are in real terms independent.
They should be able to demand an explanation from the management's why adequate return has not been provided to the shareholders.
They should be in a position to question the manipulation of market by playing against the tide if it seems desirable to do so.
They should be in a position to counter the manipulation of the market by these large brokerage houses.
They should be able to have a constant dialogue with the management's to ensure that the shareholders' rights are protected properly.
CODE OF INVESTMENT: Due to change of investment pattern in Pakistan, more institutional investors are stepping into the equity market.
Some of these institutions would be investing for a shorter period of time purely for the purpose of trading and others would be investing on a long-term basis as part of their investment strategy. By putting restrictions on the investment in government securities of retirement and gratuity funds, there should be a constant growth in the institutional investment for equity market and it seems desirable that SECP, Ministry of Finance and State Bank of Pakistan should together come forward and develop and regulate the investment code for these institutions to observe certain code of conduct to operate in these equity markets.
This should provide stability to the capital markets and should help restore confidence of the small investors in these equity markets that will further strengthen the industrial and corporate sector.
Unless we revive our own confidence into these markets, we should not expect that foreign direct investment would come forward for our rescue.