Investors in the stock markets are protected from fraud and illegal activities by relevant independent government agencies. In South Africa we have the Financial Sector Conduct Authority (FSCA). The FSCA through the Financial Advisory and Intermediary Services Act (FAIS Act) obligates individuals and bodies to be registered and licenced before offering financial services. This creates confidence and integrity in the financial system and competitiveness in the global markets. The Johannesburg stock exchange (JSE) is well regulated and has attracted international capital thereby expanding and diversifying the investment base. This is attested by some foreign companies which have primary and or dual listings on the exchange.
Laws and regulations are protecting investors and the general public from malpractices and abuse by criminals in the investment space. The following are some of the mistakes made by investors:
Failure to understand legislation/Consumer awareness
Understanding legislation and how investors are protected from illegal activities in the financial markets will reduce losses and attendant costs. Investing in unregistered entities is against the law and investors will lose their hard-earned money as they are not protected by existing legal frameworks. It is of paramount importance that investors invest in comprehensive knowledge before committing their hard-earned financial resources into the markets. It is not only knowledge about investments in shares but also legal knowledge on the structure of financial markets. Before legislation is passed by parliament into law it is first sent to the public soliciting comments about its impact on the investment community and the public at large. Some investors do not even participate or follow the processes. An investor should participate so that they stay ahead and are better informed.
Reporting complaints
Treating customers fairly is the cornerstone of every company success story. Investors should be aware of how their respective stockbrokers and companies and the exchanges manage their complaints and the entire complaint management process. They should have easy access to company complaints management materials so that they are well informed. Confidence in the markets is key to encouraging other hesitant investors to come on board. The law obligates financial service providers to give customers available options for escalating their complaints in case internal complaints resolution has failed. In addition, the client should be made aware of the legal process required to approach external complaints resolution frameworks like the Ombud.
Placing orders
Some investors without the necessary knowledge just buy shares without following their needs, risk profiles and objectives. The right order type is dependent on each individual investor’s plan. For example, a market order will be filled at the current available price while a limit order will be filled at a specific price and quantity. Differences between these two order types boil down to strategy and objectives of the individual investor. Understanding each order type and how it fits into your investment plan and purpose is vital.
Risk management
Risk-mitigating portfolios to withstand volatility helps in achieving investment objectives. At the initiation of an order, investors can place stop losses to minimize losses within risk tolerance levels and appetite. In addition, the use of derivatives as risk mitigants is also important. For example, after buying shares in the stock market, an investor can also buy put options to protect the downside thereby minimizing losses. As the specific company’s shares price goes down, the loss is reduced by the gain in the put option position. This strategy caters well to crisis situations like recessions and financial crisises. Holding company shares also gives knowledgeable and sophisticated investors the ability to sell call options based on their current shareholdings. However margining requirements and unlimited losses with this strategy makes it costly and only a preserve of a few. In essence the idea is about protecting the value of your portfolio.
Red flags
A company may exhibit signs of weak fundamentals, an inability to innovate and continuous borrowing to cover or hide underlying problems. Deteriorating cashflow and liquidity imbalances are cause for concern. The informed investor should reallocate capital or exit the position.
Value trap
Buying shares in a company at low prices with promising growth but the company fails to deliver growth and improve its fundamentals due to weak management, poor strategy or obsolete technology.
Illiquid shares
Some company shares have low trading activity and wide bid-ask spreads, which signify illiquidity. If you buy these shares, your ability to exit the position may be limited, as there are likely to be few or no buyers.
Residual risk bearers
Investing in ordinary shares carries residual risk. In the event the company is liquidated, the sale of assets to pay off creditors will be prioritised according to prevailing loan agreements or a court process. However, shareholders will only be paid after all other creditors have been paid first. If the funds are inadequate to meet all liabilities, shareholders will bear the loss and their shares will be worthless. Investors need to know the processes of company liquidations, business rescue and the transition of public companies into private companies, along with the associated effects on their portfolio.
Capital gains
Investors should understand how gains are calculated on their portfolios. If you buy a share at R20 and the price moves to R30, the positive difference R10 is the capital gains. This will give them better control over their portfolios.
Dividends
Dividends are a source of income to investors, especially when investing in dividend aristocrats’ companies. These are companies that have been paying dividends consecutively for the past 25 years. Some pay dividends monthly, quarterly or annually. The investor can structure the dividend income strategy based on their objectives. It is important to have income every month which you can reinvest or withdraw funds as needed.
Annual general meetings
As a shareholder you are invited to attend company general meetings or extraordinary company meetings to pass special resolutions. This will give you the chance to ask pertinent questions about the company and vote on issues on the agenda. Interacting with other investors will add value and knowledge and expand your investment horizons. Attending is key in unlocking and soliciting answers from executives about strategy and innovation and ability of top management to steer the company through deteriorating economic environments. For example, the company might call for a special vote on additional fund-raising initiatives. As a shareholder it’s an opportunity to get clarification about the likely impact of every decision on your investments and you can strategize to neutralize the negative effects earlier. Some investors do not even follow calendar events for the company they are invested in thereby missing opportunities to augment their portfolios. In South Africa there is a Stock Exchange News Service (SENS) communication platform, where all public companies communicate with the public about sensitive company matters which affect investors.
Cyclical companies
There are seasonal companies which perform well in some seasons due to their nature or cycle of production or demand. Agricultural companies tend to do well during the farming season and perform badly thereafter. Share prices will therefore fluctuate depending on the season or cycle of production and demand. It is therefore vital that investors invest in companies they are knowledgeable about as well understanding their effects on the portfolio.
Green Economy
The world is transitioning to a low carbon environment due to dangers of climate change. This transition, along with accompanying regulations will make some companies assets redundant unless they can be multipurposed for other uses. An expert investor should be wary of available and impending legislation which could affect current portfolios negatively. Reallocating capital to suit the transition is likely to create wealth for alert investors.
Future of stock markets
With the emergence of innovation in blockchain, decentralisation and Artificial Intelligence there are bound to be changes in the structure of capital and stock exchange markets. Fractionalisation of shares in the cryptocurrency space creates more investors in the markets. Payment systems turnaround times are going to be reduced to same-day processing, creating more liquidity and market activity. However, there are more risks like regulatory gaps and investment scams. It is vital investors understand investment scams in the markets. The following link from the Financial Sector Conduct Authority is worth reading: https://www.fscamymoney.co.za/Financial%20Protection/More%20about%20Scams.pdf
Sources: FSCA Money
