Managing Investment Risks by using Collective Investment Schemes

Collective Investment Scheme (CIS), also known as unit trusts or participatory interests are investments in which many different investors put their money together into a portfolio, and then these pooled monies are managed by professional investment managers. These professional investment managers invest the pooled money in different asset classes ranging from shares of listed companies to bonds, money market instruments, to property, etc. This way risks that retail/individual investors cannot manage or mitigate given their limited skills in securities analysis, gets managed by professional investors on their behalf.

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 is the Unit Trust of Tanzania.

The unit price 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, also known as Real Estate Investment Trusts (REITs). I will focus on CIS in Securities – what are 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, 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 regulator 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.
• Different investment options — CIS 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 part 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 licensed 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: Open-end fund: this is equitably divided into units 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 unit price and each time units are redeemed, the assets sold to enable redemption matches the prevailing 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 type of CIS issues a limited number of units in an Initial Public Offering (IPO). These units are then traded on a stock exchange. If demand for the units 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.

In many markets the less sophisticated investors who want to participate in the stock markets are protected from the swings of the markets and their implications by investing using CIS. Our experience is that this is the one area that needs to be developed, currently, other than UTT, private sector is yet to actively participate in this key space of the capital markets ecosystem.

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Stock Exchanges for Sustainable Development Goals

As part of the global community Stock Exchanges across the global are required to step up and engage stakeholders in the capital markets eco-system (i.e. regulators, investors, financiers and businesses, etc) on their role towards creating better communities. In evaluating the 20-Sustainable Development Goals (SDGs), one will clearly find that four (4) SDGs are relevant to stock exchanges, and that exchanges are best positioned to support these goals. The four goals are Goal 5 – Gender Equality; Goals 12 – Sustainability Information; Goals 13 – Climate Change; and Goal 17 – Global Partnerships.
And so, to start contributing to the achievement of the SDGs, exchanges can make a difference with these 5 steps:
1. ESG Reporting Guidance – Exchanges are required to assist companies by providing guidance in making sustainability information public.
2. Dialogue – where Exchanges can engage fellow exchanges and investors and issuers as well as other stakeholders, in sensitization and voluntary compliances
3. Sustainability Products – Exchanges are expected to help incentivize and mobilize finance for SDG areas through products such as Environmental protection, Social Responsibility and Good Governance (ESG) indices and green bond listings.
4. Listing Requirements – where Exchanges are required to strengthen their listing requirements to encourage the disclosure and use of sustainability information – especial ESG related information.
5. Join a Global Partnership: Exchanges are encouraged to join the UN-Sustainable Stock Exchange (UN-SSE) Initiative as partner exchanges and participate in its workgroups to share best practices and promote sustainable markets.In mid-2016 the Dar es Salaam Stock Exchange made a conscious decision to join the UN-SSE Initiative. And, for the past two and a half years we have focused on engaging our members to raise awareness and sensitizing them to appreciate their role in creating a better world in course of their investments, capital raising, running businesses, etc. Our engagements have been to extent of Capacity building workshops, enhancing follow ups on continuous listing and membership obligations – especially in the area of transparency and good governance.
The other initiative towards these ongoing engagements has been the launching of DSE Members Award, which is annual event involving collection of data and information and our members about their practices and whether in their undertaking, among others, the aspects of environment protection, corporate social responsibility, gender equality, and good governance are clearly considered, monitored and reported. These activities culminate into a final event, of recognizing, and awarding members that have performed better than others in these specific criteria. To our estimate, this initiative has sharpened awareness of ESG, Sustainability reporting and Responsible investing.
Why does this matter? the global interest in sustainable investment is a catalyst for change and some DSE-listed companies, especially those which subsidiaries to multinational entities have made some positive strides in the area of ESG practices and disclosures. As we move towards integrating sustainability reporting as part of our continuous listing obligation and making these part of the listed companies annual reports, which we intend to achieve by 2020 — sustainability thinking into business strategy should be embraced, not only by listed members of the DSE, but other categories of members as well – i.e. stockbrokers, nominated advisers, custodian banks, etc.
As mentioned above, in 2016 the DSE signed into the United Nations (UN)-Sustainable Stock Exchange (SSE) Initiative — a project of the United Nations co-organized by the United Nations Conference on Trade and Development (UNCTAD), the UN-Global Compact, and the UN-supported Principle for Responsible Investment (PRI); partnering with other key stakeholders including the World Federation of Exchanges (WFE) – to which the DSE is an Affiliate member, and the International Organization of Securities Commissions (IOSCO) – for the objective of providing a multi-stakeholders learning platform for stock exchanges, investors, regulators, and companies to adopt best practices in promoting corporate sustainability. In collaboration with investors, regulators, and companies, they strive to encourage sustainable investment.
Being a partner exchange to the UN-SSE Initiative, among other requirements is for the exchange to promote sustainability thinking and strategies as well as to consider ESG factors more explicitly in their practices and disclosures/reporting, in line with international best practices. Our purpose real is about trying to get the market to think more holistically about what is important, then disclose this thinking to our stakeholders, and embedding these factors, and hopefully change their behavior on matters of environmental sustainability, becoming more inclusive and socially responsible, becoming gender sensitive in their choices, as well as pursue and practice best standards of good corporate governance – including become more transparency in their disclosures, not only in relation to the past, but also the future of their businesses.
Some of the exchanges, even in our continent, have already included sustainability and ESG reporting in their listing (membership) and continuous listing (membership) obligations rules. Stock exchanges in South Africa, Egypt, Morocco, etc are in this stage already; other exchanges have creating rules for listing green bonds – South Africa, Egypt, Mauritius, Kenya, etc stock exchanges have green bonds listing rules already, while others such as Nigeria have created Responsible Investment Indices – aiming at sharpening the awareness of responsible investing. For the DSE, as I indicated above, we are at the sensitization and awareness creation stage as well as encouraging voluntary disclosures. However, the intent is to have these issues embedded in our rules by year 2020 – later this year we intend to share with our members the Model Guidance on Reporting ESG Information.