Recently EPF has declared 4.2 per cent dividend for the citizen. As a professional in fund management industry, I would like to provide some information so that we have a clearer picture of developments in our stock market.

As we all know, the government has a few state-owned investment arms in the business (Khazanah, Danarharta, EPF, Permodalan Nasional Berhad and more recently, Valuecap). These big players can easily move the Kuala Lumpur Stock Exchange composite index (KLSE CI) up or down.

Yet every single time the market index dropped (In May last year, the KLSE composite index was around 800 but now hovers between 625 and 635), foreigners are blamed.

In actual fact, the KLSE have failed to declare who were the big block buyers or sellers of those index-linked stocks (Tenaga, Telekom, Maybank, Sime Darby, etc). If more than 40 per cent of big blue-chip shares belong to government investment arms, how is it that foreign investors are blamed for the drop in share prices?

Beside the KLSE stock market, we also have another market called the Malaysia Derivatives Exchange (MDEX), which allows people to short sell KLSE CI futures contract for hedging purposes. However, based o­n the statistics released by MDEX, domestic fund users account for o­nly 6 per cent of the derivatives market in 2002. MDEX statistics show domestic positions are much too little for real fund-hedging purpose.

This is how the hedging mechanism works: based o­n the contract value of KLSE CI futures, o­ne contract is equal to KLSE CI times RM100 - this means that o­ne contract of KLSE CI futures is worth RM62,500 when the CI is at 625.

Based o­n this Beta = 1 ratio, a fund manager can estimate how many lots of KLSE CI futures need to be hedged against index-linked stock portfolio during the bearish trend. For example, if my portfolio (all blue chips) is worth RM130,000 and Beta = 1 against KLSE CI, then I need to hedge (short sell it) 2 lots of KLSE CI (contract value = RM62,500 X 2 lots) so that I can avoid the market downfall.

If the market dropped to 525, my losses in portfolio are around RM20,000 (625 - 550 = RM20,000), while my profits in KLSE CI futures would also be RM20,000 (short sell 625 and buy back 525 = RM10,000 X 2 lots).

If this mechanism was properly deployed by government investment arms, I don't think all the funds would have declared losses, even taking into account the aftermath of the 1997 financial crisis. But apparently the mechanism is not effective, as the EPF have now been giving less dividends while PNB and other state funds have shown losses o­n the portfolio.

Since the hedging strategy is not employed, it is easy to suspect that some fund managers may misuse the strategy for their own benefit.

For example, say fund manager from 'P and B Sdn Bhd' has 300 million Maybank stocks. o­n the last trading day of the month (also known as settlement day, where the KLSE CI Futures has to be closed), if the KLSE CI is 635, the fund manager can start accumulating short-selling position at 635 into his account - say a few hundred lots. Then what he will do is to dump down all his Maybank stocks in the last 30 minutes of trading hour causing the composite index to drop down a few points from 635 - lets say 5 points, making the settlement price 630.

If all the KLSE CI futures contracts he short sold earlier is settled at 630, then you can see how this can profit his own account if he had done this systematically from month to month, since this product (KLSE CI future) was launched in 1995. The fund manager has nothing to lose because he was selling public-funded Maybank stocks.

If there is no 'hanky-panky', the KLSE should announce to the public who was selling large blocks of index-linked stocks and who was buying them. This should be done every week without fail, so that we are not just randomly blaming market drops o­n o­n foreigner selling, especially when the proportion of foreign investment has been drastically reduced following capital controls.

I hope this letter would create some awareness and ensure that government servants (investment arms fund managers) are not taking advantage from the public funds allocated to them. The prevent this, the KLSE should announce the names of big block sellers for index-linked stocks during settlement day of KLSE CI futures (at months' end) to prove integrity of the stock market.