There are many avenues of investments in Pakistan according to the requirements of an investments of an investor. Some investors prefer to have a certain level of assured income on their investments together with the safety of the Capital. Such investments are made in government securities, government guaranteed bonds as to the repayment of principal and the return thereon, government sponsored savings schemes and also those saving schemes which have been sponsored by financial institutions, Commercial Banks etc. with or without a government guarantee for safety of principal or the return thereon.  

In other avenues of investments, stock market stands in the forefront. Investment in shares does not guarantee any fixed return but higher income is possible with accompanying risks. Identification of shares for investment based on dividend yield and capital gains is the basic function of investment banking. The performance of the share of a company depends on the performance of the company, government policies including fiscal aspects, behaviour of the particular sector of the economy in which the company is placed and the economy in general itself. There are other factors which affect the performance of a share on the stock market and which will be discussed later.

There are two stock exchanges in Pakistan at Karachi and Lahore. About 540 companies are listed on these Exchanges and 12 companies are in the course of being listed. Of these companies share of about 200 companies are actively traded. After having described salient features of share trading, the investment approach, in the shares will now be discussed. An investor has to consider various aspects before he decides to invest in a particular share.

Normally past dividend payment record, dividend yield, prospects of future dividend distribution, price/earning ratios, general economic conditions and other aspects as mentioned earlier are taken into consideration and a decision arrived at. The criteria for selection of a share for investment may not be based solely for a dividend yield, which may even be less than the rates prevailing for fixed returns but for the prospects of capital gains also. The area of capital gains has been the most attractive phenomenon in share investments but it has its own limitations owing the demand and supply factors.

In these contexts of fixed returns and stock market returns, let us confine ourselves to the current conditions prevailing on the stock market to understand the prospects of a Modaraba certificate as an instrument for investment. The behaviour of price pattern on the stock market upto March/ April 1991 can be described as normal, although erratic during the period of Gulf crisis from October 1990 to February 1991, when subdued conditions prevailed. The Stock Exchange shares prices index at that time was quoted around 1400 to 1500 as against the present index of around 3200. When the federal budget for 1991-92 was presented in June 1991, restrictions on foreign investment in stock market were removed. Investment banks and companies in Hong Kong, England and Singapore etc. evaluated the possibilities and potential for returns as compared to investment opportunities in stock exchanges of other countries where foreign investment/local investment is possible.

They found Pakistan Stock market more attractive and Stock Funds were floated in Hong Kong, England and elsewhere for the purpose of investment in Pakistani shares and securities further aided by rupee exchange rate. No sooner the foreign investment started flowing into the stock exchanges, the market initially assessed "the approach" of foreign investors, identified the persons/brokers through whom such purchases emanated and above all the shares selected and purchased. When the "interested shares" were identified, prices of such shares started rising from July /August 1991 at a pace never witnessed in the history of Pakistan stock exchanges. Local investors also sought those shares in which foreign investors were interested thereby resulting in "overheated" conditions. The selection of "interested" shares was made from Textiles, Fuel and Energy Sectors, all multinational companies and other miscellaneous Pakistani companies, having a desired EPS and P/E ratios. The market capitalisation rose by about Rs.90 billion in five months, raising the turnover to about 500 million shares for the year against 220 million last year. The operational strategy in the stock exchanges underwent a radical change. The operators realised that apart from the existing Pakistan funds, there were more such funds in the offing in foreign countries and therefore embarked on building up of portfolios of those shares whose EPS and P/E were nearer to that of foreign investors standards at much higher prices. This situation provided and opportunity to small investors who mostly unloaded their holdings at unexpectedly higher prices to make windfall gains. Hue and cry was raised in the press about such inflated prices of stocks with apprehensions of a collapse. Corporate Law Authority issued a press statement clarifying that stock markets are undergoing an adjustment after the removal of restrictions on foreign investments and it was not unusual in foreign stock markets to transact on yields as low as 2 to 4 per cent but nothing was mentioned about the impact of colossal volume of trading in those markets.

The share holding pattern of listed companies in Pakistan is more or less as follow:

SPONSORS                                       — UPTO 60 percent

FINANCIAL INSTITUTIONS       — 20 to 25 percent

GENERAL PUBLIC                         — 15 percent

The recent upsurge has resulted in diversion of available float towards foreign funds/buyer mainly from general public and to some extent from sponsors. The concentration of holdings in the hands of foreign funds/buyer is fraught with obvious dangers of mass unloading. It is a common belief that present purchases will be held on a long term basis. What is not clear is as to how at such low dividend yields of 4 to 5 per cent, the shares can continue to be held for initially 4 to 5 years. The portfolios of shares require roll-overs at appropriate occasions and when such a situation arises will the Pakistanis or other buyers be able to purchase at such exorbitant prices. Will a crisis like recent "Black Monday" on New York stock exchange is in store for Pakistan stock market or to a lesser degree like that of Hong Kong market a few years back? Perhaps next 3 to 4 months pattern of trading will provide an answer.

In these circumstances, the prospects for Modaraba have to be reviewed objectively. The concept of Modarabas requires providing of funds by one party and the management by the other. While the Modaraba companies and Modarabas Control Ordinance was promulgated in 1980, it was not until 1985 when two general purpose and perpetual Modarabas were floated and listed on the stock exchanges. These were followed by sporadic floatation in 1988, and 1989. The business of Modarabas being based on profit and loss sharing according to the tenets of Islam required approval of religions board. The basic concept of a Modaraba, i.e. finances of one party and labour of another party underwent a change in 1989 when the sponsors and their associates of a Modaraba were required to contribute 50 per cent of the capital of a Modaraba and the balance by the general public and N.I.T. This requirement provided a fillip to those who could arrange large sums through "Directors Quota" and float Modarabas whose profits are totally tax exempt subject to distribution of 90 percent dividend. On 31.10.90, 11 Modarabas were listed on the exchanges whereas in December 1991, 32 Modarabas stand listed and 4 Modarabas provisionally listed.

This sudden spur in floatation of general purpose Modarabas and that too in quick succession raised doubts in the minds of the public that Modarabas may be misused for ulterior motives. Such apprehensions were caused mainly due to the failure of the BCCI followed by the collapse of cooperative societies in the Punjab. It was such a fiasco that according to the unofficial estimates about Rs.25 billion were involved and the federal government had to take immediate steps to liquidate the assets of these societies and which process is still continuing under the aegis of the Punjab Government. Immediately after the failure of the cooperative societies, the press started speculation about the fate of Modarabas. Articles from Islamabad based correspondents of English language dailies mostly projected gloomy picture. The Ministry of Finance took cognizance of such apprehensions and acted through Corporate Law Authority and the State Bank of Pakistan. Consequently all Modarabas will be regulated by the State Bank of Pakistan as Non-Bank Financial Institutioms as from 1st January 1992. In the meantime market prices of Modarabas remained depressed, although lately some improvement has been noticed.

While the necessity of State bank control over the activities of Modarabas can not be denied nor it can be described as "over-regulation", where the apprehension expressed in the press really justified? About Rs.2 billion have been subscribed towards capitalisation of Modarabas. The Modarabas were not authorised to accept any deposits from public. Then what was the reason for the creation of a scare. How could the public suffer except to the extent of their subscription to the certificates of Modarabas and no Modaraba Certificate was being quoted below par even during those days. Unfortunately the psychological impact of the fall out of the BCCI and cooperative societies scam was so depressing that there was bound to be reaction to the press reports. The Corporate Law Authority therefore reviewed the situation and stopped consideration for approval of general purpose Modarabas except for banks and financial institutions and increased the contribution of the management company in a modaraba from 10 percent to 20 percent and reduced the "directors quota" from 40 percent to 10 percent. Only specific Modarabas would be permitted. These steps will restore confidence of the investors in Modarabas.

The instrument of Modaraba Certificates is like any other share certificates and the determination of whose price in the stock market is also subject to the same approach as for a share certificate. In fact the provision for distribution of 90 percent of the profit and consequent tax exemptions are highly attractive features. The nature of the business of a general purpose Modaraba, approved by the religions board, normally consists of leasing business, Morabaha, Musharika, Modaraba, agency business, capital market operations and other miscellaneous approved business. It is such a wide spectrum of the activities that if properly managed a Modaraba can derive the advantages of Leasing Company, short terms Morabaha advances, transactions in the capital market and a combination of other business. Being in such a unique position and having the advantage of tax exemptions, a Modaraba certificate can be described as most attractive instrument at the present price levels. In the context of the present market conditions discussed earlier, it appears the foreign buyers have not yet caught the fancy of investment in Modaraba certificates as they have done for other sectors but no sooner the recently floated large number of Modarabas settled down and start showing expected performance and results of both domestic and foreign demand for Modaraba certificates is bound to rise when the prices of Modaraba certificates with higher yields, may shot up at the same rate as has been witnessed in case of shares recently.

*The author is the Managing Director of First Professional Modaraba.