MARKET DATA REVIEW : Collective investment schemes for better 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 fees, 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 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 three to five 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 adviser 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 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 closed-ended CIS in our market. We can therefore urge our banks, securities brokers, fund managers, investment advisers to consider structuring these products and introduce them into our market.

Mr Marwa is chief executive officer of the Dar es Salaam Stock Exchange Email: [email protected]