Investors: On Business Ownership, Dividends and Capitalization of profits

Shareholders attitude towards management is largely determined by management’s demonstration of performance as far as company’s strategic, operational and financial performance is concern. Shareholders has the right to demand for clear and satisfying explanations when performance results appear less than what should be, and yes shareholders have the right to demand for improvement, or even consider the removal of underperforming management (via a Board of Directors) – if it comes to that. As it turns out, poor performance has an impact on the investors’ returns, share prices, valuations, wealth creation as well as sustainability of the company. However, as the process requires, with very few exceptions, that underperforming management are changed by action of shareholders during their Annual General Meeting (AGM). Good governance standards and practices requires that it is the responsibility of the Board of Director, who are also entrusted with such fiduciary duty, to place, replace or remove companies’ management, of course on behalf of shareholders.

Investors: dividends vs. capital build up

Dividend payments are dictated by the company dividend policy, normally a frequent subject of debate between the investing public, majority shareholders and company management. In general the investing public wants a more liberal dividend policy, while management (and sometimes strategic investors/majority shareholders) in most cases prefers conservative dividend policy which allows companies to keep the earnings in the business to strengthen the company by enabling availability of efficient financial resources for future growth and expansion. And so, in a way management asks shareholders to sacrifice their present interests, benefits and preferences for the good of the enterprise and for shareholders future long-term benefits. The basic argument being by paying smaller rather than liberal dividends the company can use the money for shareholders’ direct and immediate advantage by retaining the funds for profitable expansions and growth.

Nevertheless, on a sweeping through history and time, the attitude of investors towards dividends has been undergoing gradual but significant changes, for instance years ago it was typically a weak company that was forced to hold into its profits, instead of paying them in the form of dividends, and the effect was almost always adverse to the market price of those shares. But currently it is quite likely that strong and growing enterprises will be the one that deliberately keeps down its dividend payments.

There has been always a strong case for reinvesting profits in the business where such retentions could be counted on to produce increased earnings, relative to when investors will be paid dividends and investing by themselves in other companies or asset classes. But, even then there are strong counter-arguments, such as: profits belong to shareholders, and they are entitled to have them paid out within limits of prudent management; that many of the shareholders need their dividend income to live on, otherwise why invest?; that the earnings they receive as dividend are real money while those retained might not be materialized or show up later; etc – these arguments are in some cases very compelling that stock markets shows persistent bias in favor of liberal dividend policies (and payments) as against companies that paid either no dividends or relatively smaller ones.

In these past few decades, however, the profit reinvestment argument has been gaining ground, informed/intelligent investors have come to accept a low-dividend-pay-out policy, this is so much true that in many cases for profitable and growth companies low dividend payments or even absence of any dividend seems to have virtually no effect on market prices (but the key word is “profitable and growth companies”); i.e. the case will not be the same for loss making companies.

All being said, it is fair that shareholders should demand of their management’s either a normal payout of earnings – say two-third of the profits – or else demand a clear-cut demonstration that the reinvested profits would produce a satisfactory increase in their investment valuations, wealth enhancement or investment earnings are more than alternative investment options. In many cases a low payout is clearly the cause of an average market price that is below the company fair value, and here the shareholders have every right to inquire and probably complain.

Otherwise, it is also important to mention and for us to understand that sometimes a stingy dividend policy could be imposed on a company either because of its financial position particularly in cases where most of its earnings are used to pay debts (according to debt conventions) or bolster its working capital or in cases where the company is in the sector whose regulations requires that a certain level of earnings cannot be paid as dividends, i.e. in the case of banks where there are sometimes thresholds and need for regulator’s approval on dividend payments. When this is the case there is nothing much that shareholders can say about it – except perhaps to criticize the management for permitting the company to fall into such unsatisfactory financial position, or complain as to why regulators in some cases and in such sectors are less considerate, as far as investors interest are concern.

On the democratization of corporate entities via inclusive ownership

Given this, that’s why the debate and movements related to the spirit and culture of distinguishing between a society oriented towards capital versus the people gets the necessary policy and political attention, especially ever since the idea of corporate entities operating as legal persons came into being. Because of this, many within societies prefers to see the relevance of companies within societies are judged based on principles of democracy, which include accountability, integrity, and transparency.

Corporate entities and human lives are greatly intertwined – corporate entities/companies as it is for humans are all persons in eye of the law. Companies are proportionally engaged in determining some key aspects of human lives – from where we sleep, to what we eat, what and how we wear, how and where we work, how we commune and communicate, sometimes to how we decide and govern ourselves, the list goes on and on. As it is for us humans, companies have their own rights and obligations, and armed with these “rights,” corporations have increased control over resources, jobs, commerce, political engagements, and even in the making of laws. And the fact that companies have limited liability – this somehow decreases citizens authority over them.

Let me draw our attention to statement that was issued sometime in 1981 and then later in 1997, and the other one  that came in August 2019 — by the Business Roundtable, a group comprising CEOs of most of the largest corporations in the US.

This “Statement on Corporate Responsibility” reads: a group of the CEOs of the largest US firms, recognizes six constituencies – customers, employees, communities, society at large, suppliers, and shareholders – as forming the ‘web of complex, often competing relationships’ within which corporations operate. It accepts the idea that ‘shareholders have a special relationship to the corporation’ but doesn’t allow their interests to trump all others.”

Here is an excerpt from the Business Roundtable statement: “Balancing the shareholder’s expectations of maximum return against other priorities is one of the fundamental problems confronting corporate management. The shareholders must receive a good return, but the legitimate concerns of other constituencies also must have appropriate attention. Striking the appropriate balance, some leading managers have come to believe that the primary role of corporations is to help meet society’s legitimate needs for goods and services and to earn a reasonable return for the shareholders in the process. They are aware that this must be done in a socially acceptable manner. They believe that by giving enlightened consideration to balancing the legitimate claims of all its constituents, a corporation will best serve the interest of the shareholders.”

As it is, this statement is anchored on the need for rebalancing the share of income and wealth in favor of all stakeholders in the manner companies are governed, and hence the case for expand democracy in companies’ ownership and eventually finance and the economy. That is, if left unchecked — corporate greed and interests can destroy the social and economic fabric of communities, where a small group of people owning and running corporations make decisions that increasingly determine overall societies’ economic, social, environmental, governance, policy and political future.

As matters stands, the richest few own disproportionate share of global capital income – including capital gains, dividends, and interests.

While corporate profits that presently go to a small number of ultra-wealthy families are at or near an all-time high, returns on other corporate stakeholders – employees, governments, and other operatives within companies’ eco-systems as a percentage of economies do not match up.

And yes, it is also a fact that those who control these corporations have strong allegiance to profits, executive bonuses, and the value of shares of companies. What happens to employees, what happens to the environment, what happens to the community in which their corporations’ function, what happens to government tax revenue income matters very little.

This type of corporate entities operations, governance and ownership is not an economic model that is sustainable for the long end. Societies can do much better and cohesively while encouraging enterprising spirits and business success at the same time encouraging more transparency, accountability, payment of fair share of tax revenue to the government, etc.

The truth is, we can grow and develop in an economic model that create jobs, increases productivity while corporate are democratized by sharing part of their ownership stake with other stakeholders – employees, customers, suppliers, communities, governments, etc. and all have a say in the decision-making process that impacts their lives, and a fair share of returns to their involvement.

That’s why the US Business Roundtable issued the statement on the purpose of corporations that came in August 2019 redefining the purpose of a corporation to promote ‘an economy that serves all’, among others, it says: “[People] deserve an economy that allows each person to succeed through hard work and creativity and to lead a life of meaning and dignity. That the free-market system is the best means of generating good jobs, a strong and sustainable economy, innovation, a healthy environment and economic opportunity for all.

Businesses play a vital role in the economy by creating jobs, fostering innovation and providing essential goods and services. Businesses make and sell consumer products; manufacture equipment and vehicles; support the national defense; grow and produce food; provide health care; generate and deliver energy; and offer financial, communications and other services that underpin economic growth.

While each of our individual companies serves its own corporate purpose but do share a fundamental commitment to all stakeholders. And so, they do commit to: (i) delivering value to customers; (ii) investing in our employees — starting with compensating them fairly and providing important benefits. It also includes supporting them through training and education that help develop new skills for a rapidly changing world; (iii) dealing fairly and ethically with our suppliers — dedicating to serving as good partners to the other companies, large and small; (iv) supporting the communities in which we work. We respect the people in our communities and protect the environment by embracing sustainable practices across our businesses; and (v) generating long-term value for shareholders, who provide the capital that allows companies to invest, grow and innovate.”

Financial Literacy for a Better Retirement

This week – from 5th to 11th October has been set by the International Organization of Securities Commissions (IOSCO) and the World Federation of Exchanges (WFE) as the World Investor Week. It is a week meant to promote investor education and protection. Capital Markets regulators and stock exchanges across the World are engaging communities to raise awareness about the importance of financial literacy and how it can improve life outcomes, encouraging people to make savings and investments as part of their lives. A the DSE we are using the week to engage the public to the fact that financial literacy, financial inclusion, inclusive economic growth, and share prosperity goes together and could be enhanced when many in the society knows how finance works.

While we are on this, let’s be reminded that the 1st of October was an International Day for Older Persons.  Therefore, in today’s article we will link these two aspects which are all relevant to our lives. Read on:

Our priorities, goals and needs change constantly as we journey through life. Lifestyle choices like cars and holidays occupy and dominate our thinking early on as we start our career, then as years go-by imperatives such as renting, buying or building a house come along.

After that we have education for our children, health care for us and our families and all the things that goes with growing families and expanding responsibilities. All the while, we have to keep an eye of the possibility of a comfortable retirement with some form of “financial freedom”.

Juggling these competing financial needs, on a limited and finite income stretches most of us to the core. However, the part of the secret to succeed in these challenges lies in starting early, making plans and sticking, as much possible, to those plans. Have you ever heard words such as “financial freedom”, “the freedom fund”, or “the Rule of Seven”? – where you are encouraged to make regular and sustainable savings in pursuing to create a fund which is made up of investments in income producing investments (i.e. dividend paying shares, income-earning cash (i.e. fixed deposits and treasury bills), bonds, real estate’s rental income, royalties, etc) whose ultimate objective is to enable you live a relatively similar life as the one you had when you were earning regular income from your day job during the active career years.

What I am saying is that you should get into the good habit of saving and investment, early in life. The earlier you start the better, because the small amounts you save and invest– with a compounding effect – turns into large sums over time. When you are trying to accumulate wealth for future, the longer you have your money invested the more it will grow in value.

The other advantage in starting early is the mindset it helps create. You begin to see savings not as some sort of luxury but as an essential part of your overall financial plan and execution. Basically, savings and investment should be an integral piece of your planning and seen as important as your rent, or loan repayments or, school fees. The best way to approach this is to have personal plans and create the budget to support implementation of those plans. If there won’t be conscious and deliberate efforts to ensure all these are put down on paper – then the follow-through would also face challenges. Unfortunately, most of us, approach matters of income and spending via focusing on the short-term, the here and now, where we act as if what is here now is far important to what lies ahead of us not so long down the line.

Because of lack of plans or the habit of putting matters on hold until the last minutes, or according priority to matters that are not, we end up spending money on things that we do not even need or know about. In this context, getting the basics i.e. personal planning, budgeting and budgetary control is essential.

Earlier [above] I introduced the concept of compounding, in accounting and finance this is a key term, and this is how it works — let us assume that your savings are kept in the form of bank deposits with a fixed term and your return is interest earnings. In this case, there will be the effect of compounding interest – meaning that the interest you earn each period is added to your principal and re-invested, so that the balance doesn’t merely grow, it grows at an increasing rate. It is the basis of everything from a personal savings plan to the long term growth of the stock market. It also accounts for the effects of inflation, and the importance of paying down your debt. What it also means is that the earlier you start savings the better. Let us assume that you are now in your early 30s and started saving, your chances of getting enough funds, not only for retirement, but also for buying/building a house, taking children to good schools, etc are much higher relative to if you started savings at 40s where the struggle to achieve financial freedom will be far much higher. Now, personal and financial planning is key – setting out your goals, setting out the plan to achieve the said goals and prioritizing objectives for executions.

But before you proceed with any savings plans, you have to map out your action plan for getting there. In other words, you need to determine if you have the spare cash to make savings. Thus, you need to construct your personal balance sheet and cash flow statement that seek answers to some important questions to see where you financially stand. Only once you have paid off all your short-term debt and you have income left over should you consider saving.

So, first thing you need to consider, is to settle your finances and outstanding high interest debts. This is not a rule but a prudent advice because if you have debt that is costing you say 20 percent in interest per annum and your invested savings is growing at more than 20 percent per annum and you can liquidate your invested savings to repay the debt, you are then doing very well, but this is often difficult to achieve and thus it is advisable or rather recommendable for you to take a simple approach, which says invest your savings, do not borrow or get into debt to make a saving investments. Look at your current financial position, i.e., your personal balance sheet and cash flow statement to understand where you stand.

In any case, even if you are on your 40s or 50s, you still have 20 or 10 years before retirement, and there is still quite a lot that can be done. It is never too late to start, what is important is that you have to have a sensible savings and investment strategy, act on it and seek help from financial advisers, when needed.

The Role of the Exchange for a Middle-Income Economy

Exchanges are important contributors to the growth and development of domestic economies. They help funnel domestic savings towards long-run investment, thus sustaining household consumption through additional returns and contributing to the accumulation of domestic wealth. At the same time, well-functioning exchanges enhance the ability of young growing companies, as well as more established corporations with expansion plans, to access the capital they need to grow their businesses.

Exchanges also provide information, offering direction, acting like benchmarks to the real economy. The development and sophistication of local capital markets can be measured along several dimensions (returns, volatility, size), with liquidity and price efficiency being perhaps the most important indicators of capital markets development.

The role of exchanges is particularly important in the case of markets like ours i.e. markets that have not yet attained the performance of developed markets and are in low/middle income country. Our kind of markets typically underperform when compared to developed markets: we are less liquid, less efficient, more volatile, and are sometimes characterized by lower corporate governance standards. Understanding what factors are constraining the development of our market is therefore of paramount importance to sustain our growth and to bridge the performance gap with developed markets.

Such understanding becomes more urgent given the impact of COVID-19 pandemic in the economy. We predict our economy to grow at estimated less of 5.6 percent, which is almost 1.5 percent of our pre-COVID projections. While, like other emerging markets, we will suffer less than developed economies, but there is an impact. As the pandemic slows down the growth prospects of some aspects of our market, it is of even more crucial importance to reignite the engine of our economic growth, by allowing capital markets to perform its activity by facilitating the allocation of funds to where they are most needed.

Capital market development and economic growth

There has been a substantial amount of research documenting how capital market development is positively related to economic growth, both in developed and in developing markets. Different channels through which capital markets affect economic development have been identified: well-functioning  capital markets increase domestic savings rates as well as the quantity and the quality of investments, they help growing companies to raise capital at a lower cost, making them less dependent on bank financing; they also encourage financial discipline and reduce the costs of information, which contributes to a better allocation of resources.

Therefore, nurturing capital markets development in a middle-income economy can be seen as an indirect way of enhancing the underlying economic conditions of a country, a task which has become even more urgent after the impact of COVID-19. Even, the most recent studies in countries such as South Africa (Khetsi and Mogale, 2015), Malaysia (Nordin and Nordin,2016), or Turkey (Coskun et al.2017), to mention just a few, have also confirmed the positive relation between stock markets and economic growth.

Against this background, some questions naturally arise: how can an exchange identify those elements that may be withholding it from further development? What changes to the ecosystem can have the greatest positive impact on the exchange’s performance? How can the exchange most efficiently stimulate the market in a way that is optimal? How can the exchange strengthen its role in rebuilding the economy in an inclusive and socially responsible way?

Each of these questions will have a different interpretation and may result in a different set of conclusions and recommendations. But regardless of the differences, it is useful for the economy to promote a general framework linking the characteristics of a market and of its ecosystem with the attributes of a well-functioning market. For example, various research shows that international investors are attracted by better stock market conditions, that is, by better liquidity, lower volatility, or higher corporate governance standards.

Research has also found that higher foreign participation and trading are in turn associated with better stock market characteristics, that is, with lower stock market volatility, an improvement of corporate governance standards and better competitiveness and profitability of domestic listed companies. This suggests international investors are attracted to better markets and, at the same time, exert a beneficial influence on them, generating a virtuous circle. Therefore, making middle-income markets, like ours, more attractive for international investors is a way to further stimulate stock market development, and, indirectly, economic growth.

However, other than that, stimulating financial inclusion on the demand side (investors), i.e. via the use of fintech as a tool to stimulate retail participation in the stock markets is recommended. As we know it, financial technology has made access to financial services easier, for companies and households alike. While this is a global trend, we, like other emerging markets face a more challenging environment than developed economies, in terms of existing infrastructure, attitude towards financial services, legal framework and overall level of technological developments. Success stories like that of mobile payments show that Fintech broadening financial inclusion need to develop tailored solutions for capital markets as well.

The element of enhancing the role of stock market in a middle-income economy would be to innovate financial products that enable retail participation in markets. As noted above, markets like ours have a challenging environment — financial institutions wishing to attract local savings need to consider that the local infrastructure, the attitude towards financial services, the overall level of financial literacy and the legal framework might not be as supportive as in developed markets. To attract domestic savings, especially from rural areas, stakeholders in the capital markets need to develop tailored and innovative solutions.

To stimulate financial inclusion on the supply side (issuers), financial literacy as a way to stimulate participation, by potential issuers, and especially small businesses is highly recommended. As it is, private companies often rely on traditional sources of finance (such as bank lending) because they are unaware of or do not have the necessary preparation to tap into alternative sources of finance. Supportive private companies with financial literacy programs can have a positive effect on listings.

Stock Markets, Development and Corporate Governance

It is self-evident that any modern economy needs, as its foundation, a solid infrastructure base: ports, roads, electricity, airports, telecommunications, railways, etc. As it were, the state, fund managers (for pensions and others), along with insurers and mutual funds do invest in assets with long term duration to match their long term obligation, and infrastructure development by nature are characteristically long dated; they offer the state, fund managers, insurers an ideal investment opportunity. For the state, it is by way of taxes and issuance of bonds. For the buyers of bonds issued by the Government, they benefit from good returns which are guaranteed, and with minimal risks. What is crucial in all of this is striking the balance, so savings and pensions also gets their way in other financial assets.

The recent trend of less money chasing the equity market and more money chasing bonds have at least two effects. First, they hurt funding private and its productivity, which is propelled by innovation and equity risk investment. Second, the trend may not be all bad, in that they do present opportunities and more attractive returns for growth investors who are willing to tolerate a longer investment horizon. At the highest level, investors – so crucial to driving capital into infrastructure, innovation and businesses that drive economic growth, to the detriment of growth tomorrow.

On the other hand, though, Tanzania’s median age is 18 years, and two third of the population is under 25 years – for such a young society, one would ask why there is an increasing preference to bond-like instruments and the structural movement of portfolios away from stocks? Pension funds, insurance companies, mutual funds/unit trusts, and retail investors are all into this trend where bonds allocation is by the day becoming relatively significant compared to equity allocation. This is also reflected to the domestic market capitalization vs. outstanding listed bonds, where the ratio has favorably changed towards bonds from the ratio of 58:42 three years ago into 43:57 ratio of domestic market cap to outstanding bonds today.  And the situation for the equity is not helped by the structural and regulatory fact in that savings in banks and pensions in pension funds don’t find their way into equity.

The recent shrink in our stock market is because investors are reducing the amount of money, they allocate to equity issued by companies, as the appetite to finance the growth of private sector firms wanes by the day. Making the situation even more difficult is our experience which indicate that our domestic portfolio investors are willing to finance, invest and trade equities of more matured companies compared to SMEs and start-ups, now amid slowing growth, investors are even increasingly pursuing stable income from investments. This means committing even greater proportions of their capital to safe assets like bonds, or established companies and projects rather than backing smaller, riskier investment in start-ups or SMEs. Smaller businesses are thus starved for capital, finding it hard to attract investments or borrow, even though they play a critical role in economy and job creation. 

The trend of less money chasing the equity market, and more money chasing bonds, diverts funds from equity risk investment and hurts productivity, reducing the capacity for innovation and enterprising, damaging sustainable growth. In as much as the stock markets represents a path for businesses to fund investment and create jobs, this “de-equitization” trend is worrisome and could be destabilizing to both the bonds and equity capital market in the near future. 

But then there is an argument that as a society we need to appreciate the march towards the existential importance of an equitable society where in part corporate entities may foster an influence as they may wish to pursue more democratized stance in their corporate and business conduct while becoming more inclusive, transparent and the willing to expand by using capital markets route. We need to weave these intents into our corporate conduct fabric. Especially the matter of corporate governance – but then where do we strike the balance, for achieving both ends? in any way we need more funds into the equity finance for private and public enterprises, and we need more investors.

A recent study by the Aspen Institute indicates that in the US more than half of all households own some stock, and for those with college graduates over 70 percent have stock holdings. This says that apart from companies accessing capital markets to finance their expansion and growth, but there is also willingness of citizens to participate in investing in such companies. In our case less than 1 percent of the populations have an investment account at the stock market.

But why does it matter? Stock markets produce much more than just numbers that scroll across a ticker. They are the center of corporate power and accountability. Each share of stock that one own, does not afford them only a share in the ownership of entities and factors of productions, but also a chance to make decision on how corporate Tanzania is run. Owners of stock elect Board of directors who oversee companies, select CEOs, establish corporate priorities – including expansions and growth which then creates jobs and revenue to the Government. And so, come to think of it, shareholding is so consequential that it enables “corporate democracy” which if understood, makes one more entrenched into the “political democracy”. Let us get more involved.

Macroeconomic Variables vs. Market Performance

There are several factors that influence share prices and the level of return for investors. Key factors are: (1) demand and supply; (2) economic variables i.e. GDP, inflation, interest rates and exchange rate; (3) corporate actions; and (4) psychological or market cycle-related factors. In today’s article, we will focus on the economic variables.

The value of the company, its return on investment and share price reflects the perception of its earnings performance and growth. If the stock market detects something about a company that may harm its earnings flow, its share price falls. If the stock exchange hears good news about the company — its earnings, new innovations, expansion to other geographical locations, etc that have future earnings growth potential — its share price in most cases will increase.

Share prices change because sellers and buyers are constantly reviewing companies’ news and especially its earnings prospects. Therefore, in this context, one may claim, there are two factors that determine a change in share prices – future expectations of earnings and the price to earnings multiples, as we have learnt in a previous article. Both factors depend on an evaluation from buyers and sellers as they learn more about and understand the listed companies.

Apart from fundamental company performance-related factors, investors are also looking at other market information, including economic news (such as economic growth, inflation, changes in exchange rates, change in interest rates, etc) and also political events that can cause share prices to rise or fall. In the short term, the share price is also affected by intangible factors such as hype and word-of-mouth.

Share prices performance on companies listed in the DSE, like other stock markets, are also influenced by the happenings of other markets and economies (though it may not be as direct for the case of the DSE). If there is a substantial fall in other major markets prices and indices, Tanzanian share prices are likely to be under pressure as well, mainly because of foreign investors participation in our market. Foreign strategic investors own a large part of companies listed in our stock market, and foreign portfolio investors commands almost two-third of our periodical trading activities.

Stock market performance largely depend on the state of the economy, economic activities, future outlook and quality of decisions made. Economic policies, among others affect economic variables which are then extended into companies’ earnings and prospects. Specifically, economic variables that affect the stock markets are:

  • Interest rates
  • Inflation or the rate of change in consumer prices
  • Rate of economic growth (measured by Gross Domestic product – GDP)
  • Exchange rate
  • The health of other key economies

Interest rates and inflation

Interest rates affect companies’ earnings directly because their debt repayment costs rise and fall depending on the interest rate changes.

Interest rates determine how much it costs the company borrows or what an investor should expect on their investments. A rise in interest rates increases the attractiveness of fixed interest investments (such as bonds) relative to shares. High interest rates also increase a company’s borrowing cost. It also means taking money directly from profit to pay the company’s bankers. Rising interest rates also affect the level of economic activity and consumer spending.

Alterations to interest rates is one of the economic monetary policy instruments used by Central Banks. Central may lift interest rates to choke off any stirring of inflation, as a result of bubbling economic activity. During a period of tight liquidity, interest rates rise increases production costs. Conversely, interest rates fall when there is ample liquidity. People have more purchasing power, which is positive for business expansion and share investment. During these times, interest rates are used as tools for mopping up excessive liquidity.

Inflation simply refers to how much the prices of the goods and services that you buy go up by each year. It is usually written as a percentage. One of the reasons that people invest in the share market is to try and beat inflation.

The stock market dislikes inflation: inflation pushes up costs for companies quicker than it can pass them on to customers, adversely affecting earnings. Conversely, when a central bank believes that economic growth needs to be stimulated or an economic decline reversed, it will cut interest rates.

Historically, low inflation has had a strong inverse correlation with valuations (low inflation drives high multiples, and high inflation drives low multiples). Deflation, on the other hand, is generally bad for shares because it signifies a loss in pricing power for companies.

The exchange rate

A company that exports or imports products or services, or has receipts or payments in other currencies, is affected by the exchange rate between the local currency and foreign currencies. The most important of these currency crosses is the rate of the local currency to the US Dollar. Higher local currency in relation to the USD, can be good for certain sectors of the economy, making both exports and local import-replacement industries more competitive. It’s particularly good for local producers and businesses who sell their products in USD but take their profits and report their earnings in local currency.

Apart from an indirect impact of foreign exchange to investors in securities (shares and bonds)— investors, especially foreign investors are also directly affected by the movement in the exchange rate. The fall of the local currency against the United States dollar have negative impact in market valuations, size of the market and indices performance but also in trading activities.


Gross Domestic Product (GDP) is the value of all goods and services produced in the economy. When GDP decreases, the economy contracts and companies’ earnings fall and when GDP increases, the economy expands, and companies’ earnings rises. Therefore, any prospects of positive economic (GDP) outlook attract investors in the market — but the opposite is also true, prospects of negative outlook in the economic activities reduces investment in the market.

The health of the key economies

Foreign (strategic and portfolio) investors accounts for more than two-third of ownership and trading activities in our local market. The recent and ongoing global case of COVID-19 pandemic has negatively impacted the equity segment of the market mainly because due to other emerging priorities, immediate cash obligations by fund managers, and the focus on less risky investments.

In the short term, when there is bad economic news – stock markets come under pressure and some of the immediate actions is the decline in liquidity, prices, indices and market size. Unless there are rescue policies and packages, it takes time before good news ensures.

Market participation, Liquidity and Price formation

Consistently with the literature, it is evident that when liquidity is low in the stock exchange, prices becomes more inefficient, and trades’ impact on prices increases. There is also evidence that trading participant types contribute heterogeneously to price formation, in most cases, with retail and foreign investors being better informed investors, while domestic institutional investors contributing marginally less to price discovery. This pattern holds for different liquidity levels, and that lower liquidity is associated with lower price efficiency and higher price impact of trades for all trading participant types. This is a normal phenomenon key to developing markets and is key in informing the enhanced growth and development pursuance.

As it were, stock markets have two main functions: the first is to provide platform for liquidity creation (and enhancement); the second is to ensure that prices incorporate new, relevant information (in the process of price discovery) and enterprises are as close as possible to the fundamental value of (listed and traded) securities. While the concepts of liquidity, price discovery and price efficiency are distinct, they are in fact closely related: not only has liquidity been found to lead to both better price discovery (Riordan and Storkenmaier, 2012; Frijns et al., 2018) and enhanced price efficiency (Chordia et al., 2008a; Chung and Hrazdil, 2010), but literature also suggests that prices are better reflective when are more readily to incorporate new information.

It is well-established that different types of market participants (i.e. retail investors, domestic institutions, foreign institutions) contribute differently to trading activity depending on a jurisdiction’s historical, cultural and institutional factors (WFE and Oliver Wyman, 2016), i.e. trading participants contribute heterogeneously to liquidity. Even more importantly, the literature agrees that different types of trading participants possess different levels of information (Chan et al., 2007; Froot and Seasholes, 2001; Gonçalves and Eid, 2017; Grinblatt and Keloharju, 2000; Xu and Wan, 2015) and abilities to interpret market movements (Dvořák, 2005), and therefore contribute heterogeneously to price formation. Thus, a question is does the contribution of different trading participants to price formation also varies depending on liquidity?

To respond to such and the like questions, a recent study by World Federation of Exchanges (WFE) used the proprietary timestamped limit order book and trades data from the Stock Exchange of Thailand (SET). SET’s choice in addition to other factors, such as specific information on trading participant categories (i.e. retail, domestic institutions and foreign institutions), liquidity — which for the case of SET is spread across stocks of all sizes, and efficient price discovery; but primarily SET is characterised by high levels of transparency, with over 95 percent of the trades passing through the limit order book, few bilateral (block/pre-arranged) deals, and no designated market makers. In addition, the Thai market has no fragmentation, a relevant feature as fragmented pools of liquidity are a confounding factor in the estimation of both liquidity and price discovery. These factors are aligned across frontier and emerging markets.

According to the study, trades between different investors’ categories are characterised by heterogeneous information contents, supporting the assertion that the interaction between market participation, price formation and liquidity defines the speed to which the growth and development of a stock market is determined. At SET, for example, there is evident that the most informative trades are between retail investors (R-to-R), between foreign institutions (F-to-F), and between retail investors and foreign institutions (R-to-F).

There is further evidence that the contribution to price discovery of F-to-F trades is more pronounced for lower levels of liquidity. Trades between domestic institutions (D-to-D) and between retail investors and domestic institutions (R-to-D) are instead the least informative.

In accordance with the study, it is evident that higher illiquidity is associated with larger price impacts for all trading participants. This evidence suggests that retail and foreign investors contribute proportionally more to price discovery than domestic institutions, which are to larger extent likely to be the buy-and-hold institutions – a similar experience to our market. The evidence that both retail and foreign investors positively contribute to price discovery adds to more value to our own experiences, understanding and lessons to be drawn for our better future.

As it is with SET, it applies also for us that domestic institutions (i.e. pension funds, insurance companies, etc) play a marginal role in the price discovery process. This pattern is consistent across all liquidity levels, though the price impact of trades increases monotonically with illiquidity for all participants’ types.

From a theoretical perspective, it is unclear who should possess better information between domestic and foreign investors, as on one hand international investors have to face cultural and language barriers that put domestic investors at an informational advantage, though on the other hand foreign investors are typically more experienced traders/investors than domestic ones. Therefore, determining whether information is largely held by domestic or foreign participants is an empirical question.

Under normal circumstances it is expected that domestic investors should have an overall information advantage, even though there are many cases where some foreign institutions are better informed and performers probably due to their superior experience in multiple jurisdictions. It is further clear that brokerage firms, who also conduct research and advisory services, have a role in providing better information, as clients of global brokers have higher long-run profits than clients of either local or regional brokerages. In our case however, the role of brokerage firms on research and investment recommendation leaves more to be desired.

Based on the above we conclude that price discovery can largely be attributed to retail investors and to foreign investors in the mid-low liquidity segments. That, trades by domestic institutions are impactful only when foreign institutions take the other side of the trade, consistently with domestic institutions being large buy-and-hold players whose trades are not motivated by speculative reasons. Under such circumstances, it can be argued that for progressive development of the market we collectively need to create structures, products, infrastructure and institutions that will enable more retail participation, this is ideal for liquidity enhancement, better price discovery and valuations as well as wealth enhancement which is one of the key functions of a stock market.

Weathering the COVID-19 Pandemic at the Exchange

Our experience with the Pandemic

The COVID-19 pandemic is undoubtedly causing unprecedented disruption to both businesses and economies and has triggered the need, for nations to delicately balance public health priorities on one hand and preservation of lives and sustenance of economic activity on the other.

In responding to the pandemic, we took measures and approaches relative to its own circumstances aligned to our specific social, cultural, and economic challenges. Some of these measures partly impacted business output resulting into renewed financing and operating models and opportunities. From the stock market perspective, central to recovery is the need to maintain solvency, attract liquidity and enable sustainable access to capital.

In responding to policy interventions (monetary and fiscal) by the Government including relief measures offered by alternative suppliers of capital, the DSE enhanced its engagement with key stakeholders to raise awareness of the alternative approaches that could be deployed to tap into pools of contractual savings through various instruments on the market.

Inarguably, the DSE, as for similar markets has over the years relied on international investors as the key source of liquidity, volatility, and price discovery. Pre-Covid, international investors contribute over 80 percent of liquidity on the equity segment, but from mid-March to-date foreign investors participation has declined to less than 20 percent of market liquidity, resulting into liquidity challenges. For cultural, structural and policy reasons domestic investors and suppliers of capital have remained narrow. Low participation of domestic investors poses the biggest threat to the resilience of the market especially under current circumstances. It has now become clear that without the support of a vibrant domestic investor base sustainability and resilience of the market could be threatened.

The one thing that is expected to challenge DSE participants, also an opportunity, is the existence of means, tools and mechanisms with capability to reach to potential domestic suppliers of capital and participants in the securities trading and investment and hence increase the domestic investor base.

Operations and Resilience Challenges – New opportunities

Whether access to capital via capital markets IPOs, or mechanisms and tools of mobilization of IPO funds, or payment of dividends and bonds coupon, or remote access to market infrastructure, etc — the silver lining seems to be on the Financial Technology (Fintechs) whose innovation will enable entrepreneurs access to capital, as well as financiers and capital suppliers to invest and get their returns back in efficient manner. Seeking to integrate technology to develop financial services with limited operational costs seems the way to go for the market.

At the DSE, we believe that Fintechs can help mitigate the economic cost of lockdowns and avoid irreversible damage to the social economic fabric of our society. That, low-cost Fintech solutions hold the key to reaching out to more than 99 percent of Tanzanians who do not have investment accounts with the DSE.

So far, mobile money developments seem to be the most utilized feature of Fintech. According to Statista Data, the mobile (money) payment market in Tanzania surpassed US$ 3.6 billion (Tsh. 8.3 trillion) worth of transactions – attributed to 23 million subscriptions – on 257 million transactions. Measured against the total population of approximately 58 million, around 40 percent of Tanzanians made use of mobile money in 2019. The same can be transformed and provide leverage into the market.

Based on the foregoing, the COVID-19 crisis provides an opportunity for the DSE and Fintechs in Tanzania to mutually engage on the urgent need to leverage on the existing development, adapt and innovate financial inclusion solutions and limit the long-term negative impact of such pandemic and provide buffer against similar crises in the future.

The DSE believe that by prioritizing Fintech, we will have ensured that the vulnerable among us not only survive new cases (if any) of Covid-19 pandemic, but also, that they are given a fair chance to thrive post-pandemic.

Enhanced Engagements with SMEs

The DSE established the SMEs financing (Enterprise Growth Market) segment in 2013. It has meet mixed outcome. Now, in encouraging more SMEs to access public capital and listing, the DSE considers possibilities of providing a platform to listing the pre-IPO SMEs whose investor base would be Private Equities (PEs), Venture Capital funds (VCs) and other Qualified Investors (QIs). Meanwhile, towards this end, the DSE is currently running the Enterprises Acceleration Program — which helps build capacities to SMEs on various aspects of capital raising and sustainable businesses management. The program also provides an opportunity to profile and enhance visibility to the public for such enterprises, providing a good platform for future capital raising needs.

The way forward — Focus on Technology and Innovations

On the lessons leant and the urgency to act that is being necessitated by the pandemic, the DSE in collaboration with development partners and government agencies are currently developing fintech solutions to enable: access to securities trading and investments; entrepreneurs and issues of financial instrument access to wider capital base; implement financial inclusions and inclusive economic empowerment policies.

Some of the several ICT projects that are geared to address the current market challenges are: (a) Mobile Trading Platform — the DSE is developing this platform with the objective of enabling remote access and increase its outreach to retails investors whose are currently not served by stockbrokers’ networks; (b) M-Akiba bonds, targeting retail investors – the DSE and other key stakeholders are developing the  Mobile Phone Platform to enable Tanzanians to invest and trade in Micro Saving Bonds enhance liquidity in the secondary market — widening the domestic investor base of the Government’s financing source; and supporting the country’s Financial Inclusion framework; (c) Automatic Fail-Over Process – during this pandemic the DSE has focused on enhancing its Business Continuity process and has automated the fail-over mechanism to the Disaster Recovery Site (DRS) to allow live trading, clearing, settlement and other operations to continue at the DRS without any interruption in case of continuing or further impact of the pandemic; and (d) Request for Quotations trading Module (RFQ) – the project whose purpose is enabling brokers and bonds traders to request for bonds prices and accept quotations from other participants in more transparent and competitive manner hence enhancing bonds price discovery process, volatility and transparency in price discovery.

COVID-19 and Opportunities for Stock Markets Innovation

Sweeping across the globe, the COVID-19 pandemic is disrupting the economic and social life of almost every society. It poses a particularly severe challenge to businesses, especially small and medium-sized enterprises (SMEs). Nimble and responsive, SMEs are crucial for sustained economic growth and employment. Market-based financing is again called upon to help corporate issuers, especially SMEs, weather the storm and capture emerging business opportunities.

Capital markets have proved their resilience and shown the strength of stock exchanges in supporting corporate financing. In response to the impact of the pandemic, market infrastructure operators across the world have maintained continuous and stable operations and been applauded for their positive roles as market organizers, regulators and service providers. Appropriate and timely contingency arrangements have been made including relaxing listing requirements, information disclosure or delisting for issuers as well as simplifying the refinancing process. All of those measures have helped reduce the impact of the epidemic and maintain the confidence of market participants.

According to the WFE’s Q1 2020 Market Highlights, the global number of IPOs and the amount of funds raised in the first quarter of 2020 significantly increased from the year-earlier period.

New opportunities

Despite wreaking havoc, a crisis can also create new opportunities. The same is true for the market infrastructure industry. Private financing boomed following the financial crisis in 2008. Since then legal restrictions for private equity have become increasingly relaxed, emerging technologies have been widely adopted, and global liquidity has increased significantly. As a result, more and more enterprises turn to the private equity market for financing. This provides increasingly mature conditions for exchanges to build private-equity platforms. Statistics show that more than 15 exchanges have launched their own private-equity platforms in the past decade, mainly in Europe, the US, and Asia.

The exchange-based private-equity platform is generally designed to serve SMEs and innovative businesses, and is strongly technology-driven, aiming to improve the fundraising capability of SMEs through new technologies. At present, represented by NPM in the US, KONEX in South Korea, ELITE in the UK, TOKYO Pro in Japan and EnterNext of Euronext, four different development models have been formed, namely trading platform, conduit platform, service platform, and hybrid platform. Through its advanced trading system and algorithm, NPM in the US provides “online + offline” services for equity transfer of innovative start-up companies, forming a brand new private-equity trading ecosystem with institutional buyers at the core.

In contrast, for instance KONEX in South Korea provides equity transfer services for technology-based SMEs. With government policy support coupled with links to markets such as KOSDAQ, KONEX has become the conduit for enterprises to get listed on KOSDAQ. ELITE in the UK is not a market in a strict sense. It provides comprehensive, full-life services for technology-based SMEs, covering competitiveness assessment, incubation, financing, and consultation. At the same time, it uses information technology to reduce intermediate costs, thus effectively cutting service costs.

Deepening innovation

“Exchange + private platform” breaks the limitation of past internal tiers of exchanges, and therefore represents a deepening and innovation of exchange functions.

Among the four types of platforms, the service platform consolidates the local enterprise foundation, and reserves a pipeline of high-quality listing candidates by providing all-round incubation services for innovative and micro, small- and medium-sized enterprises. The trading platform meets the development needs of innovative enterprises and the diversified investment needs of institutional investors, and fully embodies the deep integration of capital, talents, and technology.

The conduit platform accommodates a number of start-up companies that have not yet reached the listing stage, and provides them with special issuance and transfer channels in advance, which improves the coverage and inclusiveness of the capital market.

Although it is still difficult to judge the prospects of the various platforms, they have meaningful explored how to actively apply new technologies, improve the efficiency of financing SMEs and support the formation of innovative capital. And here I would like to focus on the V-Net platform launched by the Shenzhen Stock Exchange in China as a case study.

Focus on Technology

Compared with its overseas peers, the V-Next platform is similar to a service platform in terms of its positioning and service scope.

Since its establishment, V-Next has provided investment and financing information services for hi-tech SMEs. Its resource pooling effect has become more and more pronounced. It has also actively adopted new technologies to empower clients and partners. As of the end of March 2020, the platform had covered 41 countries and regions in the world. It has served about 12,360 technological enterprises (or projects), gathered over 7,700 investment institutions, over 2,600 listed companies, and about 20,000 investors, and raised RMB 41.5 billion for technology-based start-ups, thus becoming a global innovation and entrepreneurship service platform with a wide range of participants, leading user base, and growing market influence.

V-Next has also played a positive role in responding to the COVID-19 outbreak by providing support for the COVID-19 Epidemic Prevention & Control Technology Innovation and Entrepreneurship Special Competition, part of the 9th China Innovation and Entrepreneurship Competition.

Identifying technology-based SMEs with advanced technology in epidemic prevention and control, the competition provided eligible companies with more policy support and value-added services, promoting the application of relevant scientific and technological achievements in frontline epidemic prevention and control and work resumption.

Generally speaking, a private-equity platform is niche market-oriented, efficient, and flexible. Driven by multiple factors such as technological innovation, and wide application of information technology, it is showing a diversity of development patterns. As long as the new round of technological revolution continues, the integration of “technology + capital” will continue to accelerate, and various innovations of private-equity platforms will occur.

For exchanges, the coordinated development with the private-equity platform not only will enlarge the potential for exchanges’ innovative development, but also provide SMEs’ financing services and product development with more choices. We believe that after the COVID-19 epidemic, “Exchange + private platform” will continue to demonstrate vitality and dynamism.

Probably this is worth of a consideration for us, to supplement the Enterprises Growth Markets (EGM) – the alternative listing platform for SMEs and start-ups, the DSE may consider providing a platform to listing the pre-IPO SMEs whose investor base would be Private equities (PEs), Venture Capital funds (VCs) and other Qualified Investors (QIs). Upon PE, VCs and QIs exit from these companies they would pursue exists via IPOs and listing in either the EGM or the Main Investment Market – this can be the extension of the currently DSE Enterprises Acceleration Program which helps in building capacity to business leaders and owners on various aspects of capital raising and sustainable businesses management.

Opportunity and Challenges of building SMEs-based Exchange

EGM, the DSE’s Enterprise Growth Market, began as a dream to offer small-and medium-sized enterprises (SMEs) a path to access the Tanzania capital market. It is a parallel equity market with lighter listing requirements that makes it easier for SMEs to list and get access to the capital they need to grow their business.

Currently, it is estimated that the SME sector makes up about 35 percent of total GDP in Tanzania, with the goal of enhancement and further contribution and growth, with access to capital/finance. Therefore the “EGM – Alternative Market” aims at playing a significant role in making this a reality, from the long-term financing perspective.

In October 2013 EGM started operations with one company listed on the day, and there has been 5 public offerings and listings since then. To ensure market stability and access (as well as opportunity) for all, trading in EGM is not limited to Qualified Investors, as is the case with similar markets in other jurisdictions.

EGM has come a long way from its modest beginnings, overcoming numerous challenges with book coverage, liquidity, participants and regulations. Each issue had its own challenges, but were carefully studied in turn, and solutions were developed that resulted in improvements in EGM market overall performance benefiting issuers and investors alike.

The Dar es Salaam Stock Exchange (DSE), alongside the CMSA (Capital Market and Securities Authority), has ever since seen some enhanced appetite – but one of the fundamental challenges has been structural, i.e. limited skills and capacities by advisers, non-availability of transactions underwriters as well as qualified investors. The virtually non-existence of the private equity and venture capital participants is also a hindrance.

Despite of these challenges, the limited awareness of the operability and benefits of the EGM is also a key challenge. For example, one of the most important features of the EGM is that of direct listing (by introduction), which allows companies to list their shares directly on EGM without a public offering – this enhances the company visibility and its profile to the investing public in case of future capital raising needs.

This can be done through two methods: floating the company’s shares with a staged liquidity plan; or through private placements.

If a company opts for the liquidity plan, an independent financial advisor provides a valuation and prepares the plan with the issuer to be submitted as part of the listing application and described in the listing document.

The private placement transaction method can take place before the direct listing in order to meet the entry requirements, which also helps the price discovery process.

A particularly important feature is to help potential issuers and increase flexibility in listing requirements, so as to separate between capital raising and the need for listing with a target for future capital raising.

There are also flexibility in reporting frequency where companies in the EGM are to report their performances in a semi-annual basis that helps such companies to also reduce the cost of compliance and lessened the burden on management, allowing SMEs to spend more time creating value by focusing on developing their core business.

Furthermore, the above combined with the decrease in the free float guard to at least 20 percent, compared to the Main Market’s 25 percent as well as the reduction in the number of shareholders to 100 compared to 1,000 in the Main Investment Market and also the amount of qualified capital prior to listing, better captures the listing and trading environment and the overall objective of facilitating SMEs to access public funds for their growth and expansion, leading to a fundamental increase in market growth, stability and confidence in companies’ governance; not mentioning its multiplier effect to the economy including jobs creations, more tax revenue, innovations, etc.

To support SMEs’ expansion plans further, DSE provides its EGM listed entities the opportunity to transition to DSE’s Main Investment Market, provided they have met all of the requirements for listing on the Main Investment Market (including market capitalization, free float, number of shareholders, etc).There are some EGM listed companies that are currently qualified and can graduate/upgrade to list into the Main Investment Market, but none of them have opted so for the time being. Much as this is choice by the company, however, the choice of not pursuing the upgrade denies the DSE an opportunity of affirming EGM’s credentials as a segment in the market that provides a fast-track to growth for SMEs and a springboard onto the Main Investment Market, indication of gradual growth and ambitious intent by listed companies.

Despite of the above, the EGM has enabled and enables businesses to fund their growth plans, provides investors with opportunities to generate financial returns and support overall economic growth.

To achieve further profiling and encourage more listings on the EGM the DSE has introduced the Enterprise Acceleration Program whose main objective is to build capacities to entrepreneurs, business owners and managers of SMEs to enhance their broader understanding of the financial markets, particularly capital markets and need to manage businesses sustainability. This program aims to increase the number of listed entities, eventually provide an opportunity for market depth and increase liquidity in the market.

One of DSE’s more recent initiatives is the amendment of its rules to provide for independent research providers to conduct research on EGM listed stocks. The results will be made available through the exchange, providing more information and further boosting market transparency. The government has also been keen to assist SMEs to list on DSE and has provided a number of fiscal incentives for companies to encourage them to make the leap onto the DSE’s EGM, creating opportunities for investors and issuers.

DSE’s main goal is to provide a diverse selection of products and services that add real value to all market participants. All changes and improvements are made towards this goal which upon crystalizing will translate into a stronger and more stable domestic market for access to long term capital and wealth creation.

DSE is proud to have been able to make such significant developments to the Tanzania capital market in such a short time. With DSE’s passion and commitment to innovation we are confident that SMEs on the EGM market will continue to blossom into much larger and successful companies, and we are honored to be able to help these companies on their journey.