First Capital Holdings: thriving in a crisis

Director/ Chief Executive Officer Dilshan Wirasekara, and Chief Operating Officer Tharusha Ekanayake

The investment institution laid the foundations for a resilient business years before COVID-19, and now its reaping the rewards, and confident about a 2021 economic recovery.

Listed investment institution First Capital Holdings PLC is having a phenomenal year and is set to break its own business record posted during the previous financial year. This means that volumes and revenue will close to double for the second consecutive year by March 2021. The company’s Director/ Chief Executive Officer Dilshan Wirasekara, and its Chief Operating Officer Tharusha Ekanayake, explain the reasons behind First Capital’s success and outlook for the economy, and the prospects for fixed-income and equities in 2021.

What is your macroeconomic outlook for the year ahead and what will the post-COVID new-normal look like in terms of the economy?

Dilshan: I like to start with the current year, because that sets some context into our outlook for 2021. With all the challenges due to COVID, we estimate the economy will contract 5-8% in 2020, and this is a significant contraction, the largest in the post-independence era. First quarter GDP surprisingly contracted, and we expect the second and third quarters to be negative as well, so the 5-8% contraction is a fairly realistic estimate. However, this means the base affect for the following year is low and we estimate the economy will recover to post 3-5% growth in 2021.

Despite the negative impacts of the pandemic, there have also been some positive developments to fast track economic growth. The government is restricting imports to boost local production and monetary policy rates were eased along with SRR cuts to increase liquidity and credit growth by making borrowing cheaper. Banks have been directed to grant loan moratoriums to help borrowers with cashflow problems.

All these lay the foundation for an economic recovery, but we will have to wait and see how the second wave is contained and when a vaccine for COVID-19 will be available. So far, three global pharmaceutical companies announced encouraging vaccine results. We believe everything points to a recovery in 2021.

Our debt structuring business has raised rs25 billion on average each year. In 2019/20, we helped corporates raise rs42 billion and we hope to exceed this number by the end of the year

Tharusha: The Budget for 2021 is balanced and progressive. There are indications that we will witness consistent policy on taxes and interest rates kept at reasonable levels. The Budget has many facets which have competing interests and need to have careful management to deliver the results. Implementation is key and we are optimistic about the growth prospects for 2021.

What are some of the exciting trends you see for your Capital Markets Advisory business? How can First Capital help corporates reset and reimagine strategy for the new normal?

Dilshan: Let me first set the context here. First Capital is one of the least affected organisations by this pandemic, and this is something we are proud of. This is because we laid the foundations for working from home three to four years ago, when we invested in digital infrastructure to enable uninterrupted remote operations.

So,when the lockdown was imposed earlier this year, we at First Capital did not experience any interruptions and were able to engage with our clients as usual. I think it was more to do with our philosophy where we wanted to empower our employees, and to give them that flexibility. We also introduced flex-hours which benefited our staff with 52% of them being females. Because we implemented these measures very early, we were able to capitalise on that infrastructure, service our clients, and carry out business transactions remotely during the lockdown.

In answering the question, First Capital Holdings is now having its best financial year since its founding over 35 years ago. In our advisory business, there is a lot we can do to help businesses ride out this crisis and uncover real value. The Country’s capital market is in a strangely unique situation with two primary needs that have emerged. First, there are certain industries and business that find themselves in dire straits and need assistance with funding and restructuring. On the other hand, there are investors or institutions with excess funds looking for attractive options in a low-interest rate environment. The Country’s capital market is highly liquid due to the Central Bank’s monetary policy easing: for instance, the banking sector has surplus liquidity amounting to about 150- 200 billion rupees. Because of the economic downturn, there are not many sectors that are looking to raise capital or even debt, so investing excess liquidity is a problem. I believe First Capital is well placed to bridge the two needs, channel funds to where they are needed the most, help COVIDimpacted businesses recover faster and help investors generate market-beating returns at the same time. This is our role as a financial intermediary and investment institution, and the present environment has increased the opportunities to play that role and have a significant impact on the economic recovery.

Tharusha: Our corporate debt structuring and securities businesses reported impressive growth this year with volumes surging and surpassing the previous year which was also our best year. We are also bullish that our structuring advisory business will grow as many companies will have to abandon existing business models. Our M&A advisory arm will also see a lot of new opportunities emerge as more companies take this route over the coming months.

We will continue to be bullish on fixed income because we know it well and have an intimate understanding of how the market works

Though the interest rates are historically at their lowest levels, the unit trusts managed by First Capital are generating superlative returns than of other comparative investments along with the flexibility and convenience which have been enhanced by the use of digital platforms. Our debt structuring business has raised Rs25 billion on average each year. In 2019/20, we helped corporates raise Rs42 billion and we hope to exceed this number this year. For the first six months of the financial year 2020/21, we raised well over Rs11 billion, so considering what we have in the pipeline we believe our debt structuring volume will exceed Rs50 billion this year. In terms of fee income, we averaged Rs100 million each year and hit Rs175 million in 2019/20. We are likely to reach a fee income exceeding Rs200 million this year. Our fund management numbers are even better. Last year, total funds under management reached Rs26 billion after averaging Rs10 billion annually over the previous years. By November 2020 assets under management reached Rs35 billion. These numbers demonstrate our ability to grow the business exponentially for two consecutive years under economic uncertainties’ stemming out of Easter attacks and COVID-19 pandemic.

What is the short-to-medium-term outlook for equities and fixed income and what factors will shape these two asset classes over the next year, and even beyond? How should investors approach asset allocations?

Dilshan: Monetary policy has been easing and interest rates are at a historical low. The benchmark one-year Treasury Bill yield is down to 5% and bank deposit rates are around 5.5-6%. A corporate debt instrument yield around 8-10%. From the credit perspective, the prime lending rate is down to around 6%. Sri Lanka has always been a very volatile country in terms of interest rates which have been very cyclical, peaking and falling every five years or so. However, we see real interest rates touch down to nearly zero for the first time in history. We have never experienced this before because Sri Lanka has always been a country with fairly high real interest rates. One may argue that real interest rates are a negative in the developed world, but that is an entirely different story.

We believe that these low interest rates can possibly be sustained for some time, despite the government’s increasing need to borrow. The Central Bank will try to keep interest rates low to stimulate an economic recovery, but we feel rates will not fall any further than they are now. So, interest rates could remain at these historic low levels for another 6 to 12 months. If inflation starts moving up from the current 5% levels, then real interest rates will enter into negative territory and we have never experienced this before.

We believe the Central Bank will hold interest rates for as long as possible but when government credit expands, interest rates will be adjusted upwards to keep inflation at bay. This brings us to equities.

There is a fairly negative correlation between interest rates and equity markets; when interest rates drop, equity markets tend to go up and vice versa. This explains the stock market rally since the economy emerged out of the March-May lockdown. By end November, Sri Lanka’s equity market had gained 1% year to date, which is quite good from a global context as the CSE was the best performing exchange world over in the month of September. There is an equity market boom with the benchmark index rallying 35% since the lockdown lifted in May, and this is mainly because of the low interest rate environment and investors looking for attractive returns with valuations lower than they were before the war ended in 2009. This is quite strange because several listed companies are doing much better now. The equities rally will last for another 6-12 months for as long as interest rates remain where they are. In terms of listed company earnings, there’s room for improvement too. There are many companies in the export and manufacturing segment reporting higher earnings compared to the previous year, so the outlook for equities is encouraging. We see new investors emerging to take advantage of the equities rally. A mobile app launched by the Colombo Stock Exchange in September has been downloaded 17,000 times and over 3,000 people have opened CDS accounts to trade in listed stocks. Demographic data suggests that people between the ages of 18-35 years are now actively investing in equities which was not the case before. So overall, we are very bullish on the equity market.

Tharusha: We have predominantly been a fixed income player with around 90% of our asset allocations in this asset class. The reason for this is that fixed-income was the best performing asset class over the last three-decades. If you look at the five-year government bond rate, or the average weighted fixed deposit rate, those are the two best performers competing against the other two common asset classes, which are equity and real estate. We will continue to be bullish on fixed income because we know it well and have an intimate understanding of how the market works. First Capital is the leading Non-bank Primary Dealer with strong research capabilities and close relationships with the issuers which gives us an advantage of cherry-picking fixed income investments for our wealth management clients. Another clear advantage we have is the ability to negotiate better yields on fixed-income instruments due to the total assets under our management, about Rs35 billion, which allows us to negotiate preferential rates compared to what individuals receive. So, we will continue to focus more on fixed-income assets and deliver above average market returns for our clients.