Collective Investment Schemes for Better Investment Outcome

One of the readers of my last week’s article thought strongly that I should, in today’s article, try to differentiate between savings and investments. Let me respond to that.

Savings is a portion of income that is not spent on consumption. It is kept to enable you to plan for your future and that of your family. You may wish to own a home and by saving for a deposit to buy the home you can then apply for a home loan and if the application is successful, you can prepare to buy a home. You may also want to save enough money to pay for your children’s school, etc.

On the other hand, investments have some of the same characteristics as savings. It is an action of preserving money for profit motives. Generally investments make it possible for you to use your money to make more money. Instead of spending your extra money, you can invest this money, either regularly or as and when you have money to invest.

In order to make savings and investments possible and part of your lifestyle, it is important that you budget for this. You should list the amounts for your savings, your investments, and your expenses out of your income and this will help you to make sure that you put money away regularly to provide for your future. One way in which you can save or invest money for your future is to put money in a Collective Investment Schemes.

So, what is a Collective Investment Scheme (CIS)?
CIS (also known as unit trusts or participatory interests) are investments in which many different investors put their money together or pool their money into a portfolio, and then this pooled money is managed by professional investment managers. These professional investment managers invest this pooled money in different asset classes. These assets include a wide range of shares of companies listed on an exchange, bonds, property and money market instruments.

The total value of the pool of invested money is split into equal portions called participatory interests or units. When you invest your money in a CIS portfolio, you buy a portion of the participatory interests in the total CIS portfolio. The assets of a CIS portfolio are held by the trustees. A closer example of this structure here at home is the Unit Trust of Tanzania (UTT-AMIS).

The unit price or the net asset value (NAV) of the CIS depends on the market value of the underlying investments in which the pool of money is invested. This unit price rises and falls (fluctuates) according to the value of the underlying investments based on daily calculations.

What are some of the advantages of CIS over direct investment? CIS provides an ability to:
• hire professional investment managers, which may potentially be able to offer better returns and more adequate risk management;
• benefit from economies of scale i.e., lower transaction costs; and
• increase the asset diversification to reduce some unsystemic risk.

There are two types of CIS, namely CIS in Securities and CIS in Property. Last week I explained the CIS in Property also known as Real Estate Investment Trusts (REITs). Today I will dwell on the CIS in Securities. And I will go straight into explaining some of the benefits of investing in CIS in Securities:

They are affordable and easy – these collective investments are affordable as an investor can invest small amounts of money. This makes it possible for more people to easily invest in underlying assets that they normally would not be able to afford.
Diversification of risk – as collective investments may be invested in a range of underlying assets, it means that your eggs are not all in one basket. The risk associated with your investment is therefore spread amongst the different underlying assets. If any of these assets perform poorly, your total investment will not necessarily perform poorly as there are other assets that may have done very well.The more diversified your capital, the lower the capital risk.This investment principle is often referred to as spreading risk.
Good returns — the longer you leave your money invested, the greater the opportunity for your investment to grow. An investment in a CIS in Securities can be repurchased at any time, however, it is advisable that you invest the money for at least 3 – 5 years. The reason for this is that the value of the units of a CIS in Securities can go up or down. If invested for a longer period of time, one can expect to see the benefit of the long-term growth in the market.
Professional investment management — an investment manager manages your investments for a fee. However, an investment manager must be registered with the Capital Markets and Securities Authority (CMSA) as a financial services provider.
Your money is accessible — CIS in Securities are easy to sell which means that you can sell all or part of your investment at any time. However, it is recommended that you invest your money for at least 3 to 5 years so that your investment can grow.
Different investment options — Collective Investment Schemes in Securities offer flexible investment options as you can make: (i) lump sum investments – these can be made at any time once you have opened your collective investment account; (ii) debit order investments – you can make regular payments, e.g. monthly, into your account; and (iii) switching – as there are many different collective investment portfolios, you can switch between different portfolios at little or no cost.
Reduced dealing costs – If one investor had to buy a large number of direct investments, the amount this person would be able to invest in each holding is likely to be small. Dealing costs are normally based on the number and size of each transaction, therefore the overall dealing costs would take a large chunk out of the capital (affecting future profits).

A choice of where to invest: It is important that, before you select a portfolio in which to invest, you first understand what you are investing in, and that you carefully consider the amount you commit to invest. A registered financial advisor should assess the amount of risk that you are prepared to take and advise you accordingly. Factors such as your age, health, income, alternative liquid assets, financial knowledge, appetite to risk, whether or not you have dependents and what your investment goals are will all influence the choice of investment.

Types of CIS in Securities: There are two types of CIS in Securities as explained below:
Open-end fund: this is equitably divided into shares which vary in price in direct proportion to the variation in value of the fund’s NAV. Each time money is invested, new units are created to match the prevailing share price and each time shares are redeemed, the assets sold to enable redemption matches the prevailing share price. In this way there is no supply or demand created for units and they remain a direct reflection of the underlying assets.

Closed-end fund: this issues a limited number of shares (or units) in an Initial Public Offering (IPO) or through private placement. If shares are issued through an IPO, they are then traded on a stock exchange. If demand for the shares is high, they may trade at a premium to net asset value. If demand is low they may trade at a discount to net asset value. Further share (or unit) offerings may be made by the vehicle if demand is high although this may affect the share price.

Our Local Experience: We have a few registered fund managers, regulated by both the Capital Markets Regulator (or CMSA) and the pension sector regulator (or SSRA). The most visible fund manager has been the UTT-AMIS, that manages five open-ended CIS schemes. We still don’t have open-ended CIS in our market. We can therefore urge for our banks, securities brokers, fund managers, investment advisers to consider structuring these products and introduce them into our market.

REITS & Closed Ended CIS for Inclusive Growth

Real Estate Investment Trust Schemes (REITs) and Closed Ended Collective Investment Schemes (CIS) may be considered, as in our environment to be somehow new concepts. However, if used appropriately, these tools can provide the way out for many people within a society to participate in the financial and economic activities leveraging on the economies of scale but also professional investment skills.

The two are actually business concepts that has matured overtime and actually has given million of investors an opportunity and exposure to the real estate sector and other enterprises in an effective and efficient manner. These concept are embedded in the idea of pooled or collective investments that provides a cost effective means for individual investors, especially those in the lower to medium end, who otherwise would not qualify for investment access either in the real estate sector or in other impactful economic activities within economy. In today’s article I will focus on the REITs and the next article will be on CIS.

What are the REITs?

REITs are real estate financing vehicles that is modelled after mutual (or unit trust) funds. They are common arrangements made for collective investments with a view to earning profits or capital gain income from real estates as beneficiaries of a trust which is divided into units. REITs are managed by either trustees or boards who then employs managers who are up to the task, leading to maximum rental income, profits and capital gains. Investors contribute money towards capital of REITs by way of units or shares in exchange for the rights to receive dividends or interests or capital gains.

Generally, due to economies of scale and making use of professionalism, REITs have advantage over direct real estate ownership, especially for low end investors who have an interest in the real estate sector. Through the sell of shares or units of the real estate REITs provide the smaller investors with the opportunity to diversify among the real estates classes and in various geographical locations.

Let us assume that, there comes a day where, either of our Pension Funds or our National Housing Corporation or Watumishi Housing or our Tanzania Building Agency or any other such Institution, decides that they want to change their property development financing model and so decides to convert some of their existing assets (properties) into units or shares and then sell these shares to individuals and institutions that have an interest on the real estates exposure, and then use these proceeds (funds) obtained by selling shares related to particular properties to build other properties and then convert those into units again and sell them to investors, and so on. What will happen? (1) there would be a another layer of efficiently priced source of financing in the real estate sector (2) there would many Tanzanian that will be given an inclusion opportunity to finance and own some part of the sector, hence a financial and economic inclusiveness (3) there would be another front for our nascent capital markets growth as to provides the platform for long term project financing.

REITs holders (investors) are then entitled to dividends emanating from rental income from the underlying property as well as capital gain income, as the value of the assets appreciate and upon the property is being put into the market.

What does it mean?

REITs own, and in most cases, operate income-producing real estate projects. The REITs structure is created to provide all type of investors (low to medium end private individuals and institutions) the opportunity to invest in large scale, diversified portfolios of income producing real estate in the same way they typically invest in other asset classes – through the purchase and sale of liquid securities. REITs may own many types of commercial real estate, ranging from office and apartment buildings to warehouses, hospitals, shopping centres, hotels, etc.
It can therefore be said that REITs provide a practical way in which investors who have interest in investing in real estate sector within the economy to invest in large scale, income producing, professionally managed companies that owns commercial (and in some cases residential) real estates.
REITs can be publicly or privately held. Public REITs are in most cases listed into stock exchanges. As of end of 2015, there were more than 480 real estate companies from more than 40 stock exchanges in the world representing an equity market capitalization of more than US$ 1 trillion.
As alluded earlier, the genesis of the REITs can be traced back in 1960 where through a legislative action, “the U.S Congress gave all Americans – not just the affluent few – the opportunity to invest in income–producing real estates in a manner similar to how individual and institutional investors invests in shares and bonds”.
REITs may invest in properties as themselves, generating income through collection of rentals, or they may invest in mortgages or mortgage backed securities tied to properties, helping to finance the properties and generating interest income from lending.
In most developed economies REITs own many forms of shopping malls, apartment building, students hostels, homes, medical facilities, office building, hotels, cell towers, etc. In these markets REITs contribute significantly in jobs creation and investment income to national economies.
REITs have many potential advantages. I will mention a few: (i) Diversification: REITs may invest in many different properties in different geographical locations within the country, bringing investment diversification by property and geography to investor portfolios; (ii) Dividends: REITs are usually required to pay a large percentage of their taxable income as dividends to shareholders who in turn pay income taxes on those dividends; (iii) Liquidity: Publicly traded REITs shares can easily bought and sold; (iv) Performance: Over the past 30 years, publicly traded equity REITs outperformed the leading stock market indices, including the S&P 500, Dow Jones Industrials, NASDAQ Composite, etc; (v) Transparency: Publicly traded REITs operate under the same rules as other public companies for securities regulatory and financial reporting purposes; and (vi) Growth: Over long holding periods, equity REIT returns have tended to outpace the rate of inflation in particular economies, helping investors hedge the purchasing power of their portfolios
Here at home, in 2011, the Capital Market and Securities Authority came up the regulatory framework (The CMS Collective Investment Scheme – Real Estates Investment Trust Rules of 2011 – to enable capital raising and financing real estates projects through REITs. This legal framework, among other aspects provides rules relating to eligibility, responsibility, key players, listing procedures, operationalization of REITs, etc. We, at the stock exchange have a trading platform (infrastructure) to facilitate listing, depository and settlement of such products.
So, the legal framework and the infrastructure to enable operationalization of the publicly listed REITs are available, it is for developers to make use of this platform to facilitate not only in enabling private individuals (retail investors) and professional institutional investors to invest and have ownership in the vibrant real estate industry but also enable real estate developers to access more efficiently and better priced public funding for speedier development of the real estate industry. In actual fact, less costly funding means lower cost for houses and commercial or industrial properties and hence more affordable houses, office space and industrial properties in our economy.
Recently, Stanlib Investments of Kenya raised capital from the public and listed the first REITs in the Nairobi Securities Exchange. Through this transaction Stanlib raised Ksh. 3.2 billion (equivalent to Tsh. 58 billion) that is now being used for acquisition of properties.

Why Companies Should Opt for IPO as Exit Route

Individuals, Partnerships, Investment Companies and Governments would normally invest in companies and in often cases would engage in the operational management of the company. These investors, mostly would have an investment plan which includes how much investment returns are expected, both in terms of profit sharing (dividends) and capital gain, in the case of exit.

In recent years specialist investment structures, commonly known as Private Equity (PE), has emerged as an important player in the investments in companies. Most of these do invest in our local companies originating from outside. In our East African region, most PE funds are based in Nairobi, Kenya where they operate from — most of them being global investment vehicles that opted to set regional operation offices in Nairobi, for obvious reasons.

So, in whatever form, individuals and firms do invest in companies for a specific purpose and for specific periods of time. During the end of that time, there are various exit route that these individuals and firm may opt. In each year, new investors will enter in companies and other investors will exit from companies. In our case, most considered exit route has been trade sale/trade buy. This is most favoured route, even during our privatisations, this has been the most considered exit route whenever the Government opts to exit from state-owned entities. That is why out of more than 350 companies that the Government have exited in the past two decades, 99 percent of these exits has been via trade sale. However, the other most effective and efficient exit mechanism which in often cases has been less favoured could be via the Stock Exchange by way of Initial Public Offerings (IPOs). In today’s article, I will explain three major reasons why Individuals and firms should consider the local Stock Market as an exit option.

Before I explain why the IPO option make more sense, let us first try to understand how these exit occurs. Traditionally, across the world, investors — private and government rely on two kinds of buyers: Secondary buyers and Trade buyers — these being buyers who are looking to gain market share or gain an entry to the new market. These approaches have long served the investment industry — it is easy and more effective to sale something to someone who is interested in it, similar in this case, selling a company to individuals or firms that have an interest to increase their market share within a certain jurisdiction or market a new entry into a new market via buying a company that has experience, customer base, distribution systems, relationships with various stakeholders, etc — seems a viable. Except for a few things —one; it is not easy, in a private market to gain a timely access to a trade buyer due to inefficiencies especially those involving lack of information. Two; It takes a relatively long time and its consumes a lot of efforts to negotiate a fair trade based on fair price and value of the business and its shares being informed by a proper due diligence. In fact a recent report by Deloitte Survey – Africa Private Equity Confidence Survey 2015, indicates that respondents to their survey explained that they were grappling with difficulties in exiting in companies they have invested in due to difficulties of getting a right buyer in the private market.

For, particular reasons as indicated in the last paragraph, that is why an IPO consideration makes great sense — both for private companies and state-owned entities, during privatisation. I will explain. Firstly, exiting through IPO route provides an investor, with exit motive, the fastest time to exit their portfolio firms as compared to other routes, as indicated above. I will be quick to admit that — yes there has been concerned from the business community that the IPO process takes to long to get approvals from both the Regulator and the Stock Market. And that, IPO and listing requirements are too requiring for many companies — that most companies, even with intent to use the stock market as an exit route, or for capita raising purpose, finds it difficult to meet IPO and listing criteria.

One, both the Regulator and the Market have recently improved their efficiency levels and hence, the time it takes to get an approval has been shortened significantly — one may cross check with those went through the IPO and listing process in recent months. Second, introduction of the Enterprise Growth Market (EGM) segment, a segment that allows small and medium enterprises as well as new ventures to raise capital and list into the Exchange, have made IPOs as exit route even a more viable option that before, due to its lower entry barriers.

My experience in the local corporate finance and transaction advisory space tells me that, for investors with a 5-7 years investment cycle and mandates — in which most PE funds falls under, it is relatively difficult to have effectively build a company and turned into a consistently operationally successful and profitable entity with a secured future. This being the case, the “at least two years of profitability” requirement for an IPO and listing into the Main Investment Market (MIM) of the local stock market, becomes a challenge to many — again this is where the EGM becomes useful, where companies may opt to exiting via EGM. Furthermore, evidenced experience shows that whenever the investment holding period is shorter, particularly for PEs, IPO exits are the most favoured approach compared to other exit methods. Most importantly, this route also provides the entrepreneurs or the anchor business enterprise owner with opportunity to regain their shareholding in the company, that they somehow lost when the exiting investor or investment firm joined the company.

To conclude, it is clear that a considerable number of investors, investment firms operators or the government, in some cases, finds it hard to make exits in invested companies. Therefore, for the sake of both the investment management industry growth and the local capital market growth and continued survival, it is important that exits should begin considering the local stock market (the Dar es Salaam Stock Exchange) as an important option to exit a company — both/either the EGM and/or the MIM segments provides such an option.

Cultural Change for Sustainable Development

As a society, we collectively agree that there is an urge and a necessity to propel ourselves from the state of poverty to plenty. We also do fundamentally agree that for us to reach at the state of plenty — we need to make some fundamental changes: i.e. from an agricultural based economy to an industrialised society. And therefore a vision or a manifesto that brings us an opportune to move towards such a direction is not only a matter of political correctness, it is a fundamental necessity in our pursuit of a happy life.

So, as we move towards such a direction we, as a society, as a country — we need to clearly underscore the fact and we consciously understand that the process may take a generation or two. What we can achieve within a decade, with all the good intent, purpose and discipline is setting the necessary ground work, systems, structure, the infrastructure as well as encourage and motivate a cultural change — the key ingredient in the process. In this article, I will focus in the last aspect — the cultural change.

As it is, once we get the basics right — such as the aspect of a society’s culture, it becomes relatively easy to pursue a cause, any humanistic cause. Addressing the need for cultural change is pivotal in the process of economic growth, or technological change or any social transformation, since culture is one of the deepest and most determinative aspect of our human lives, our development and our growth.

And so, one of the key ingredients to national economic success, for example, is the culture of innovation and experimentation, the culture of intellectual freedom in which new ideas, technological methods and new products could emerge — all these are cultural embeded aspects. And since all these depends on human resources capabilities within a society — it then says that for us as a society to achieve the ambitions that we have set before us, it is fundamental that one of our key priorities should be to rigorously work on social fabrics that defines us as a society, as a country — the culture. To be able to change ourselves in any how we want, will require us to educate our communities and the society about where we want to go and the means (including skills and competences) that will get us there. Once we, as a society, decides on this — we should also try to undestand that it may probably take a whole generation to train us so that at such given moment we have skilled, intelligent, knowledgeable people who can become productive in whatever socio-economic venture we are set to pursue.

Who shoould do it? We may largely somehow agree that the role of the state in a society is to create a setting or an environment in which people can live happily and where they can freely express themselves and pursue thier productive ambitions (within the rule of law which is also well administered). However, we may also agree that despite, globalisation effects, the state may still have the role to create or influence some cultural attributes within a society i.e improving the level of its human capacity within its human development goals. And this is important because in the after all the best way that the society can sustainability develop is fundamentally embedded in what people do with their lives — this is what determines economic success or failure of a society, of a country.

In the case a society is fortunate enough to have a good cultural backdrop embeded within its own social and economic fabric –such as a belief in thrift and hardworking, a belief in continuous learning and self improvement — such society should be grateful. However, the truth is, not so many societies are such fortunate. In such cases, which are many, it is the society’s leadership that should step in to enable the creation of economic growth based on proper cultural values and facilitate the necessary changes especially in crucial moments of moving from one social and economic structure to the other, i.e. agricultural to industrialization.

A society that has a culture that doesn’t place much value in continuous learning and scholarship, a society that put emphasis in hardwork and thrift, and deferment of present enjoyment for the better future, and insisting on doing the right things; for such a society, despite a good vision, properly documented manifesto, timely legislative actions, etc — it’s process of growing will definitely be much slower.

The argument so far has been, to be able to succeed in this endeavour, the society needs to get the basic fundamentals right, i.e getting the right cultural mindset — for instance in addition to attributes mentioned above, encouraging savings and investments, developing the habit of spending within our means and encouraging the right financial discipline (for individuals, to families, to community, to the state), providing high quality education, embracing and adapting economic and technological changes that matches our current situation as we imagine it while at the same time re-create its future, as well as developing practical industrial policies with clearly targeted sectors, are some of the crucial elements for sustainable and inclusive growth that is based on how the society culturally behave.

Having dwelt so far in the general framework of my argument — let me conclude by trying to reflect my thinking on the cultural change we need in the way we can use the capital market to finance our growth and development. We may all agree to the idea that in this time and age capital markets can’t be ignored and treated as a foreign idea that can hardly be adopted and/or positively embraced. Any idea that taxes or bilateral commercial loans or aid or assistance will continue to be sustainable tools to finance our current and future development is futile and inconceivable — a society that embraces such ideas as ideal requires a mindset change — a cultural change. Any form of sustainable industrial development, commercial enterprises, social and economic infrastructure projects in an economic structure where the state’s role in economic development is largely reduced, such an economy can’t be financed using the conventional historical tools. Throughout human history, major projects within a society have been financed by way of collective agreements, by systems and structures that encourages putting resources together for a common end, systems that encourage partnerships and trusts in others’ strengths, structures that encourages people to think and plan in a sustainable mannerbeyond their current situation and/or the first generation; sructures that encourages good governance and transparency. And, the currency that enables this to happen has been the capital markets.

Our historical and current situation as a society, as far as this context is concerned has been: majority of our national development projects have been largely financed by donors; most of our enterprises remains small to medium years in and out and are largely financed by individuals and families or friends and to some extent by commercial banks; we have a business society whose culture despises transparency and good governance; our enterprises can hardly sustain beyond its first generation of entrepreneurs; we have a situation where some good business ideas are afraid to tap into capital markets for their fruitation and sustainability because they are afraid to pay taxes by being more transparent; our local governments can’t finance their local development projects via issuance of municipal bonds in the capital markets; we have a vibrant real estate sector whose projects developers refuses to use Real Estates Investment Trusts (REITS) — a financing tools that is more inclusive and economically empowering because of fear of change; we have a capital market that lacks the vibrancy necessary to engineer the country’s social economic growth, despite 20 years of existence; etc. Why is this the situation? Many reasons — but as human being we have been endowed by our creator with the ability to change our situations the way we want. But it starts with ourselves.

Upon a moment of generational cultural change we may see these ambitions coming to pass — after all, they are the right things to do.