For Asanka Herath, Head of Equities at LYNEAR Wealth Management, listed equities remain the strongest asset class in 2025 and beyond. The economy is poised to recover with stability, and listed companies will likely sustain earnings growth. Investors are becoming more mature—relying increasingly on fundamentals and less on sentiment—while speculators are burning their fingers for misreading the market. However, Asanka argues that Sri Lankan investors must invest purposefully, understanding their future financial needs and investment horizons to build long-term wealth.
Sri Lanka’s equity market rose by roughly 60% between the period just before the presidential election and the end of December 2024, as measured by the S&P SL20 index. The rally was broad-based but disproportionately driven by the banking sector, which holds significant weight in the index. Since then, the market has entered a phase of consolidation.
The All Share Price Index stood at 10,588.26 points in the days leading up to the 2024 presidential election in September. By the end of that year, it had risen 50.6% to 15,944.61 points, driven by a broad-based rally. The upward momentum continued into early 2025, with the index peaking at 17,156.05 points in February—a further 7.6% gain. However, this was followed by a sharp correction, with the index falling 10.3% to 15,395.33 points.
This has prompted investors to ask about the rally’s sustainability. Some have speculated that the gains were driven by short-term sentiments rather than long-term fundamentals. Others are asking whether equities remain valuable after such a strong performance. According to Asanka, the answer is unambiguous.
Fundamentals Driving the Equity Market
The market’s rise was grounded in fundamental shifts. Equity valuations had been compressed for years, reflecting political uncertainty, macroeconomic instability, and unresolved debt restructuring. With domestic and external debt restructuring largely complete and a new government displaying a commitment to macroeconomic prudence, the risk premium attached to Sri Lankan equities has declined. This, Asanka argues, explains the market’s sharp repricing.
Despite this repricing, Asanka sees room for further gains. The market’s current price-to-earnings ratio is approximately 8.5 times, well below the historical average of 11.5 times seen during periods of similar or higher interest rates. Since the end of the Civil War, prime lending rates have been higher than they are today, 74% of the time. In those periods, equity valuations were also higher. Investors need to appreciate that the interest rate environment is likely to have fundamentally changed, and we are unlikely to witness materially higher interest rates anytime soon.
Higher taxation on fixed income further shifts the calculus in favour of equities—current money market returns of around 10% drop to 6.4% after tax. In contrast, equities remain taxed more favourably. Domestic investors are likely to find equities more attractive as a result, not just due to valuation but also because fixed-income returns, after tax, are unlikely to meet real return expectations.
Asanka expects equities to deliver 30% to 40% returns in 2025. This view is based on favourable domestic fund flows, earnings growth among selected companies, and a reversal in foreign investor sentiment. Given limited alternatives, he argues that domestic funds are already reallocating capital toward equities. At the same time, earnings growth among the investable universe of companies in LYNEAR’s coverage is projected to be 30% to 40% over FY2024 to FY2026, with most of the growth concentrated in the next 12 months.
The data support the earnings expectation. Economic indicators such as the Purchasing Managers’ Index show improvements across services, manufacturing, and construction. Activity in these sectors is not only recovering but accelerating. High earnings growth at a time when valuations remain low suggests that equities may become even more undervalued on a forward basis, reinforcing the case for further re-rating.
The third factor Asanka highlights is foreign capital. Between 2012 and 2017, about $800 million entered the Sri Lankan equity market, only to see an equivalent amount exit between 2017 and 2022. Since 2022, early signs of foreign investor re-entry have emerged. Some foreign investors who had been net sellers since 2017 became net buyers from mid-2023 onwards. This trend has continued even in 2025, with a large institutional fund group re-entering Sri Lanka through one of its smaller funds.
This trend may gain momentum if Sri Lanka sustains macroeconomic stability. Global capital is gradually reassessing emerging and frontier markets, which have underperformed in the US over the past decade.
Investor Shift
In Asanka’s view, the recent rally was not speculative. It was driven by a reduction in market risk premium and improvements in earnings. Prudent macro policies, political stability return, and debt restructure completion have reduced the overall market risk. Led by impairment reversals in banks and a pickup in economic activities, listed equities began to report earnings growth. Investors waiting for a resolution to macroeconomic uncertainty and direction on earnings growth saw an opportunity and entered the market.
Speculative activity, which defined much of the 2020–2021 cycle, was notably absent. The absence of sharp movements in share prices without a corresponding improvement in fundamentals distinguishes this rally from past episodes.
Further, investors who attempted to speculate on short-term price movements have underperformed. Many failed to recognize the underlying macroeconomic improvements or appreciate the speed at which the market would price in the debt restructuring and policy stability after the election. They missed the rally altogether or paid a material liquidity premium due to remaining on the sidelines or trading in and out.
Asanka sees this as a turning point: the underperformance of speculative traders could reduce their influence, encouraging a more mature investor behaviour focused on fundamentals.
He believes this behavioural shift will persist. As market participants see the benefits of holding undervalued, fundamentally sound stocks—and the costs of speculative trading—the incentive structure will change. Over time, this should lead to more stable market behaviour and returns that are more aligned with economic fundamentals.
Missing Out
Beyond short-term market dynamics and equities, Asanka is sceptical of the broader investment approach of many Sri Lankans. He argues that most individuals fail to plan for their long-term financial goals adequately. In particular, they underestimate the returns needed to meet future objectives by not accounting for inflation.
For example, even with a modest 6% inflation, prices will double in approximately 12 years. That means investors will need at least a 12% annualized after-tax return to achieve a 6% annual growth in real wealth over 12 years. Investors who ignore this dynamic risk losing purchasing power, even if they achieve positive nominal returns.
Sadly, Asanka observes that a significant share of household and institutional wealth remains in low-yielding deposits and money market funds, which will barely yield above inflation in the next 12 to 18 months. He believes this reflects a fundamental misunderstanding of inflation, investment risk, return and liquidity, resulting in the destruction of wealth by many investors.
Asanka advocates for goal-based investing. Investors should define their financial objectives, estimate the required wealth at a future date, assess how much they currently have, and calculate the return needed over the intervening period above the inflation rate. Only then can they determine the appropriate risk and asset allocation.
Given the current environment, he believes that fixed income will struggle to meet even modest post-tax return targets. Meanwhile, he believes a well-managed equity portfolio could deliver an expected return of 25% to 30% over the next 12 to 18 months. While real estate and private equity are likely to yield strong post-tax real returns in a recovering economy, liquidity and accessibility remain a concern in relation to those asset classes. Therefore, some exposure to equities is essential for investors to meet return targets in the mid-teens or higher.
To support more deliberate asset allocation, firms such as LYNEAR Wealth offer a range of investment options through mutual funds. The funds allow investors to allocate capital across equities, short term and long-term fixed income instruments to allow investors to achieve a wider variety of investment goals. As of February 2025, LYNEAR’s Dynamic Opportunities Fund had returned 3.9% year-to-date, compared with a 1.4% gain in S&P SL20 after generating 48% in 2024. Its long-term fixed-income fund posted an annualized return of 9.4% year to date, while the money market fund yielded an annualized rate of 9% during the same period. These figures reflect varying performance across asset classes and the role of managed portfolios in navigating shifting market conditions.
As the economy normalizes, asset returns are likely to diverge. In such an environment, indiscriminate investing is less likely to succeed. The role of the fund manager becomes more critical. Asanka believes that investors must now assess risks more carefully and make deliberate choices about allocating capital.
Equities’ Promise
Asanka does not believe the market has peaked. He expects equities to outperform fixed income over the medium term, including in 2026. Changes in fiscal dynamics underpin this view. The government is running a primary surplus and is expected to increase it further in 2026. This, combined with Treasury having built-up a cash buffer, reduces the need for government borrowing.
Many local investors are unfamiliar with this shift in economic policies. As a result, they continue to see the equity market as a trading vehicle rather than a platform for long-term investment. Asanka believes this perception will change, especially after corporate earnings reflect improved fundamentals and interest rates remain stable.
In his view, the absence of high-yielding fixed-income alternatives will continue to support domestic flows to the equity market. This in combination with gradual foreign flows will see the market generating steady returns through 2026 and beyond, supported by more stable macroeconomic environment and improving corporate earnings.
After years of stagnation and crisis, Sri Lanka’s equity market is undergoing a structural reset.
According to Asanka, the gains of 2024 are not the result of speculation but a rational response to improved corporate and macroeconomic fundamentals and de-rating of overall risk. The current environment could offer further upside if earnings growth materializes and fiscal discipline holds—investors who ignore this and rely on short-term strategies or cling to low-yielding fixed-income risk falling behind.
For now, the challenge is not simply identifying attractive stocks but understanding the new investment landscape and adapting to it purposefully, Asanka advises.