A GO RATIVE STUDY ON PORTFOLIO PERF CE OF MAIN BOARL) AND SECOND

BOARD COWmIIES.

BY

Gobi Nath AJSI D. Marimuthu

A Research Paper Submitted in Partial Ful the Rquirement usiness Admini

@miti Malaysia Smw& 2002

APPROVAL

I certify that I have supervised it conforms to acceptable standards adequate, in scope and qualify. as a reSlear(~h Corporate Master in Business Adl11inistr'atil'm

~ Assoeiate Professor Loo Sin Supervisor

This research paper was submitted Business. UNIMAS and is requirements for the degree Administration.

Assoc. Professor Dr. Shazali Dean.FEB UNIMAS

DECLARATION OF COPYRIGHT

Name : .. ~~.~ ... N~t'!. ........... .

Matric Number : .... M.::. C!.:J;.:: .. t!:?~?.: .. :.

I hereby declare that this research is the result of my own inVestigatioDS~ expect whore Otherwise stated. Other sources are ada1owledaed. by tootaotes giving explicit references and a bibliography is appended.

Signature

: ........ $. . ::. f!::-. :?:~:P. ~.

C Copyript by Gobi Nath AIL Marimuthu and University Malaysia Sarawak

iii

DEDICATED TO

AND SON MRS. TBANAVATHY & SARVESB

AND

FOR MY MOTHER MADAM K. LETCHUMY

ALSO

ALL FlUENDS

iv

ACKNOWLEDGEMENTS

The author would like to extend his foremost gra1titu(le his comments and

guidance during the course of preparing and writing up this project

I:)DeClat thanks are Exchange (KLSE) library staff and Bank Negara staff for their help

are also conveyed to the KLSE for granting the right of using its library as a source of reference.

Lastly, the author would like to forward his appreciation to all those QlreCtlV or mdlrectlv

completing this project especially to his wife, son, mother and

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ABSTRACT

study an analysis on finns listed on the Kuala Lumpur Stock Exchange (KLSE). The size etTect is analysed over three sub-periods to investigate if the size is stronger during crisis. The results show that size etTect pronounced on shares prices of finns listed on the KLSE during the period from 1995 to 2000. The returns on small finn portfolio are

larger on medium

vi

ABSTRAK

_ ..... ,."" .... terbadap disenaraikan dalam Saham

Kuala Lumpur (BSKL) . Kesan sampingan untuk firma bersaiz keeil telah dikaji dalam tiga tempoh. Ini bertujuan

sama sampingan berpengaruh serta ketara semasa krisis ekonomi Malaysia Hasil kaJian sampingan adalah. ketara alas yang di BSKL sepanjang tempob bingga Pulangan saham untuk portfolio yang mempunyai firma saiz kecil adalah daripada ke alas potfolio besar. Kajian saiz firm.a W.CIUUUUK:illn

perman yang signifikan dalma pembentukan portfolio serta KCI,utulsan pelaburan di ursa ......... """'-<.

TABLE OF CONTENTS ptJJgg

.. Approval page .............................................................. 11 on of Copyright .................................................. 111

Dedicated to ................................................................. iv edgements ......................................................... v ..................................................................... vi

I..

.. .......................................................... .v11 ........................................................... v111

*..

CHAPTER 1 IINTRODUCTION

Introduction., ................................................................ 1 and Corporate

............................................. 3 Requiremnt ...................... 5

.................................................. 7 ..................................................... 8

......................................................... 8 study... .............................................. 9

CHAPTER2 LXTERGTURE WVlEW ........................... 10

on .................................... 14 ............................................ 14 emmt ..................................... 17

Selection of F h s ........................................................... 19

io Pe ance ........................................ 19 x ................................................................. 21

Index ............................................................... 21 ary of Por$olio Performance ....................................... 23

CHAPTER5 CONGLUSfO .......................................... 25

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CHAPTER ONE f/ ;

BACKGROUND OF RESEARCH

1.1 INTRODUCTION:.

An investment is a commitment of funds some positive rate of return. If the investment the return will he' comtnensUiatewith Generally, investment is distinguiShed from ·"'IIJI'W'YIUIlL'''' .. ''U' ... ·

horizon of the investor and often by the nSK:·relm1l cna~ac:tefllst1c~S the investment. The.modem approach emphasizes risk· and return estimates tather estimates; The return· and risk estimates. are del'lenClent price and the accompanyiJig dividend stream,

Portfolio is a combination of assets. In. consist of securities. Traditional portfolio plaltmll1lg "4~""""'·"". selection of those securities that best desires of the investor. Modem portfolio th.,.,,,.,,,,,, sug:gests traditional approach to portfolio analysis~ sele:ctl(m may well yield ·lessihanoptimutn·,resnlts. scientific approach is needed. This approach ,"UU'.MU

ofrlsk·and retUrn' of the portfolio and attitudes toward a risk .. feturn trademOff stemming. individual securities. In,this 'connection, ultimate <1e(:lSl.()ns made areas follows:. '.

a) What securities' should be held b) What is theatriount to be allocated to

These decisions are normally made in two steps. First, and risk are estimated over a forward holding Second, .......... , .... -risk estimates are compared in order decide available fundsllmong these securities ona cOlltmmng

2

phenomenon is are COlltstr,Unc:d resources limitation such as time, staffing llndecomputer access; .

1.3 RELATIONSHIP BETWEEN':'RISK,··ANJ)·CORPOAATE PERFORMANCE

Investment under uncertain environm.ent make the future returns risky. are two types of risk. The first type:0frisk is

has as the business cycle, inflation rate, interest,.te, exchange rates and so

of macroeconomic factors can be predicted with

also knoWn as systematic risk ornondiversifiable risk. The is peculiar a it can be eliminated by forming a well diversified portfolio. This risk is unique risk, finn specific risk,llonsyStematic risk or diversifible risk. Total theory, risk canbe'thesame astbtalrisk in a portfolio investment when aU

specific ~ks are fully eliminated by well diversified portfolio.

However, in the real world, total risk will be higher than the market risk as it is impossibJeto eliminate all·theunique risks;

is potential Cllused by changes in the"nlarket·· interest rates. If ,market 1ntp_d

rates rise; then mvestment's value and market pPice will fall·tmd

2) Bull-Bear market risk is the variability in market returns resulting market "'''' .. ,'''''''''.

market rise significantly and constantly or a period called bull :market. i . .~ .

3) Manqement risk 'is .the:···risk· that caused . deci$ions, made·· by top executives. ,It, isfotind ·that owner:' U..lml~~~ C~()I1>()ra<tlO.tlS are than . employee-managed firms. This findings implies can

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4

1 .. 4 ~ AND SECOND BOARD COMPANIES REQUIREMENTS· .

To be listed in the Kuala Lumpur Stock Exchange. companies must fullfll a number of conditions, .·depending on .whether they are small or ....... "' ... " are to be listed in KLSE.

1 .. 4.1·Mam Board Companies

e)

MiIllimum paid-up ca):llltai shares of notless than 10 Sen each.

the company's A"""" ........ time· of listing shall be in the hands of public· shareholders.

which held by Bumiputera shareholders falls under Second bullet point) for the purpose of

Nall0naI :lJ1eve:lop:meJllt Policy can up the 2S%public spread.

minimum number 1000 shares each, as follows:-

NomiMlvtible of_ed tmd PiIIil-up CtIJIittI/.

RM 40 million to RM 60 million

:aM 60 toRM 100

:aM 100 million and above

Mini".,. "umber of . slulrdolden

750

1000

1250

s

1) Tho compa.nyllMtldllld:ve'.a.u_Il • ..,. .. At'ttIIr4lJt,lprefltldl:COrcl for the past thtee (3) to five (5) .M fimm'bi)!i"" .... ;1U.,...te after~tax profit of at least RM 30 million over the aforesaid period

. Gf~:;Ili'IJJ .. i ...... _iadiuimldDaftet--.ptQit of : iRM8:J:QiIHOIl'fOrthei.m ..... ~!,.nI.li

1.4.2 SeeoRd Board COIDpaaies

a) Minimum paid-up capital ofRM 4Or~m.ili0Dl~~ shares of not less than 10 Sen each.

,1\- /'

j' ,

c) At least 25% of ~ CGmpayslissUe4_pai.d..i-upj'capitsli .. at the time ofUstina shall be inb bands of public shareholders.

"" , d) The .. ~"issued.amI,paid4:lpcapital!; of! the . C@lDpa.D.y(;:wl!J.ireh is

held by employees.

e) Up to'tOO'" 'of the issued and paid-up eapital!.Of~tkei···company which is held by Bumiputera investors (or IS% if the

;:i",.lsbareholCJels, faUs~"'Id·huU.etpOiDI) for !iClle!'~ of complilD.ce. ,wft1aIt1te:,NatiOnal.:D8WdqpmeDf ftlJicy eanrDlalcie up

. ~tbo ,2S%~'.pUblic!.spread.

e) The company is required to have uptJD.!il~.i 11.11Iet\me'Wina minimum number of public shareholders holdiag not less than

! l000I''''s",~ as&UoWl:~i " •. !'

1000

JlM. ··lOOmWion .. above

t) The com~x • .,Utd have.~ uDiDi' for~ ~~(3),:to t.ive{~)~. ...... . .. , yeat:S ... ~ after-tax profit of at least RM 12 million over the aforcuidperiod

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of uninterrupted after-tax profit and a minimum after-tax profit of RM4 '

IMPORTANCE OF STUDY.

a simlllle task. Thisjs beatusethere' are many 'unpredictable factors and forces

the thus determine' market., prices of shares .. · Given . tbis'scenario, (laJl

IOrmWlate a wumulg It is believed that'in the long.run, 'coIlUllonstock ownership can be rewarding for those who manage theirinvestmertts with skill and care. can a nUlnDt~r include market value, trading volume, PIE ratio and stock return. In

There were studies. which' have·established a relationship between

Reinganwn (1981) have found that small finns .. have···higher risk adjustedstockr~s. Banz that return 'on

exceea returns on large even after adjusting for differences in market risk.

Previous research has shown that on average, small fums earn higher risk*adjusted than . Throughout firm effect has been discussed with relationship between price earning· 19832), *Of-the-week return (Hanis. 1986;Keim; 1984).rtrading volume (James Edmister. intc)mJ.ati(m e<mtelllt offmancial statements (Zeghal •. 19M).1and broker neglect (Arbel and Strebel. 1982): 'These effects have been examined

and . using different risk adjustments (Friend and Lang, 1983), different portfolio tornnat14:>n methods 1984) periods. }' ,

This study aims to . provide evidence in Malaysia that· win eD1lance

size firnns can provide higller returns than larger firnns. This study will use the Main board and Second board index

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effect. It usosthe weekly closing prices datase1lected from the KLSE from 1995 to 2000. The 'small fum portfolio will be benchmarked &.pinst the large portfolio in order to ascertain the existence of size effect in companies listed on the KLSE during 1995 to 2000,Furthermore, the study seeksi01lrovidea;more<receBt evidence on the size atIect on different economic conditions.

This . study explores··the small firm effect 'onMalaysian listed Industrial and P,roperty· ,hares .. (Main Board) and all the. ,tock, in Second '. Board.·.· It will provide some updated .. evidence· on the size effects and· further· investigate the, impact of the economic· crisis on size effect. It is. hoped' that this would give a clearer view on. whether firm size wiU·lead to an upward' tevision'in the fmn'sstock price and tbrther increase the investors return: '

1.6 OBJECTIVES OF THE STUDY.,

This study attempts to achieve1thefollowing objectives:-: 1) To see the effects of size on portfolio retumsin KLSE .. ' 2) To. i~vestigate if the size effect . on portfolio performance is

unique to economic conditions, that is to investigate ,ize effect in three different .. sub-periods .(pre crisis, during crisis ad ~post crisis) in Malaysia.

Market",alue ratio", re1ates the,firm's stock price toits1eami!1:JS. md book.value per share. '. ;

Size Effect· -·Refersto the phenotmmon .. whereby.the·average.retums or'smaU ·f'iInM;ize •. stocksare •• substafttially. higher. than larger. firm.. simstocks; , ' ....

Steck .Retuns- The·total gain tdividend + capitd .gaits) in an.asset over a period of time.

Capital MarketlLiae "7'.The linear risk/return tmde-eff forinvesterS spreading. their'money 'betwRnthemarket.pottfotiotand1;risk '"""free assets· ..

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9

CIIAPTERTWO·

LITERATURE REVIEW

~\leral empirical evidence:on the size on ctO(~unlen1tect. Low capitalization stocks are .predominantly

.......... ,.,.rII stocks is'lO be primarily· ,price effect (Kross, 1985). The relationship between the return and ma.rkel value bas beet!' widelyexamine<4

on NYSEcomrnon stocks' in, 1936 - 1975.' On earJ[le<l higher risk adjusted returns than

large NYSE fmnsand thisj~8izeeffect' has been reported to exist at least forty years. The ~size effect' is evidence that pricing model is misspecified and not clear

occurs for small firm while there is little differences showed in return between About half of the size effect can be the use of versuscah::lulati()fl~of'risk4dJusted~tetums with significant (Roll and Blume and Stambaugh. 1983). Harrera MJ; 'and Lockwood. LJ: (1993) studiea the firm effect in the Mexican StockMarket tlSing December i t992: .The average retums;arenegatively reltaLteCl

firm, size ,fortlte:Mexican Stock '\01"" .. "' ........ Y sc~J)al'8titlg the effects of beta an size.

Infrequent trading may, give rise to ;underestimated. due the high of returns in·sdeh circumstances

Howe1l1er: the firrrir:effects are found to be non-significant after controlling for differences price ratios (Bas~ 1983). Brown. and suggested that the size effect is not stable during period relation between size and. abnormal

1973 period. However, a stable negative relation existed from 1974 - 1979. In consistently outperform small finns.

reported that average returns of the small firms exceed those of the large firms by more annual basis. However, the evidence lnWlCalc:a between the estimated beta of the sman

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11

sys1tematic relliltloin exists betWeE~n samrple period and month in a year.

;ftl\!~lt'I"I.lpu'a(1c~n between . return ~rved;Therefore, they sUl'portedthe CODfirme<i used of.beta as . '.

Dowen;Richard J:~ Bauman, W.Scott (1986) carried outalresearch on size

CODlmc,n .. """,.... over . period shu\vslhat the size'effect is thtlmost,coosisten.t over··timeandthe PIE

was used~toextttmne the effect of PIE· mtio • and ·t"im1"..sizel :on common

resulLts mlllcaIe that oort:tolll()S

security high over pdriod;' 'studied~ Portfoti() including ,·small. ··tim .. ptovided .positive abnonnal . period. the of'~large

tinderperformed their average size and ....... ' .... ".kU " \, t

Examination tin4,.:·sig:Mficant relation betweeh .. average tetum···aJId four othetI . . . DleftsUl'!eS

between··market value 8DClt:Ielm:D

that, :there is no evidence,tbat the si%oletieetis due. the· relation firm the resl111ts SU'Dl00n

hypothesis the .. size effect· . endogenous.·idelltity relating market value of a firm to its ~_ rate: ,. .' .. ; '. .

I:nfNquent trading. may live·· rise to uhderestimatedbetasfor fim1s.due ta·the higft;alltocorrelation;of ietunisin sueh;eircums&ances

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(Roll. 1983). However. the. small firm <lItIect is found to be non­significant after controlling for differences in both risk and earning price ratio (Bas\!, 1983). : ,

Lee and Porter (1998) provided additional evidence on the relationship between share price~d fmnsize and concludedthaHbe share price is at least as significant as firm size in explaining the behavior of stock returns immediately before and after holidQ,ys. It shows that share price is a fundamental variable. underlying previously reported firm size anomalies and is' 'consistent with the evidence presentsd by Bhardwaj and Brooks '(1992).

StoU, and. Whaley (1983) conducted an Malysis on monthly retul'l(l data. on listed stock in;New York Stock Exchange (NYSE) from 1960 to 1979. They found the smaU fmn's stocks tend to Iutve lower;prices and higher bid spreads. the transaction costs are relatively high for these stocks. This is consistent·· with Rollts·and Reinganum's .(1983) conclusion that small finns' transaction costs are larger than the larger firms.

Nathan Siva has explored the differential information explaining the sizeetIectand tested whether .the size effect is actually a differential information effect. lbis data .consisted ofarandom sample of 200. f~ traded either on the New York· Stock Exchange (NYSE) or the American Stock Exchange (AMEX)·for a twenty year period from 1975· to 1994. Monthly returns are· used in this study and market values of the equity are used. as measures of firm size. The study hag. proven that the small firm effect has been i\dly explained by the differential information hypothesis.

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CHAPTER THREE

METHODOLOGY

3.1,SAMPLE SELECTION AND COLLECTION.' , "

saUl'PU.'! was Industrial Property sector Main Board and aU the firms in, Seco1ld Board .. Weekly shares prices data from January to used for The stocks selectedfo:r thisstudy,were to be categorized'.into small and portfolios. Board's industrial property; portfolios were' categorized·as large finn, while;SecOnd Board "firms considered as sman'portfolios, To be included'in the sampie.a ,tim has incorporated '

< ,-" i'

actively period sttldi~:so that the 'Volume traded of the' study periodwOuidbe

trading wete used. The· stockretumfor eacbportfolli) fumed is 'basedonan , portfolio ' tbe method: used by K.eirn

(1983) and Brown (1983).The study period sub-periods namely~Pre Crisis (Jan 1995 - lUbe 1997), During Crisis July 1997 "'" 2000) for different size of portfolio;' The share price data ftomBloomberg ahd

Dairy were used determine the 1I"phl1'ftll!

counters selected from KLSE.

3:.2 METHODOLOGY

3.2.1 Stock Returns

Weekly returns are calculated using the weekly closing price and the on a stock for t is as foUows:·

=== (Pjt-Pj,t-l)

14

Where,

Rjt = The rate of return for Stockj on .week t

Pjt =: The closing Price of security jat the end of week t

Pj, t 4- 1 := The closing Price of security j:a~ the end of week t - .1

3.1.1·RETCRNFOR PORTFOUO

The weekly portfolio returns were computed by c using. equally weighted portfolio approach. Expected return on any portfolio, can be calculated as below:

Rp -l/.EWiRi

Where,

Rp = The expected return on the portfolio

Wi = The portfolio weight for the j th security

Ri = The expected returncm the security.

n ' "" The number of different securities in the'portfolio

For this study, the portfolio's return is taken as the equally weight average of the return on. each security.

3.103 THE MEASUREMENT OF RISK (BETA) "

Portfolio risk is· measured ,by the standard deviation ~retums of portfolio,calcuiated ,using, ,eithef' 'the .historical retumsover time or the expected returns in the future. The mean and .standard deviation of the annual return of a portfolio, calculated over a number of years, can be found using the following equations.

,3"

MeanreturnR = !:Ri/n

Standard deviation =..J L (Ri - R)21 n

15

The simple form of diversification to consider is that using a two­share portfolio. The extent to which investors will be able to reduce unsystematic risk using 'a ,two-share portfolio depends upon the correlation can be qualified by calculating the correlation coefficient of the returns of two securities, which can take any valucin the range -1 to 1. The beta of a portfolio can be defined as an index of responsiveness of the changes inretums of the portfolio relative to a change in the stock exchange or 'market'. If a stock or portfolio has a positive beta, we would expect its return to increase whenever the overall stock market rises. Since a stoek's beta <measures 'its contribution to the riskiness of a portfolio. beta is the theoretically correct measure of the, stock's riskiness.

The CAPM (Capital Asset Pricing Model) is an exante model, which means that the entire variable represents before the fact, expected values. In particular. the beta coefficient ,used in the SML equation should reflect the expected volatility of a given stock's return versus the return on the market during some future period. However. people generally calculate betas using data from some past period, and then assumes that the stock's relative volatility will be,the same in the future as it was in the past.

<

Beta can be determined from the data by using regression analysis; equation Y "'" a +bX used, Y isdependent;variable, a is the 'constant, b is the slope coefficient and X is the independent variable. Once the data have been plotted: and the regression line has been drawn, we can estimate its intercept and slope, the a and b values. In this study, beta ,coefficieDt';wiU be calculated usiItr spreadsheetpto~ EXCEL. Simply inputs the return data ;and .then use" the ,)spreadsheetfs regression routine to calculate beta. While it is mathematically possible for beta to be negative it is very rare in practice as few companies experieneein~ng,;ritums;7 iff timesi t of j ~6:dOmic downturn. The beta of a portfolio is obtained by weighting the individUal security betas. by their telati¥e~muket :value {example the numi1Jet" of'sharesmultipliai! by, their ,pri~!and} divided!by the' total market value oftheJportfolio). '

3.2.4 DETERMINING THE RISK FREE RATE i

The risk free rate means that the security has no risk of default, no maturity risk, no liquidity risk,: 00 risk· of Joss if infJation incteasod

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