Pooled investment funds can unlock long-term financing sources

This the third piece in a series of articles whose objective is to share and engage us with the concept of pooled investments so we can ultimately see their (pooled investments) potential in further exploring and mobilization our financial resources to finance our own development.

With this I also intend to remind us on the difficulty that we, as a society might have and the inefficiencies we might continue to create amongst us due to failure in coordinating ourselves better so that we can eventually pool our minimal financial resources together in a manner that would in the end collectively benefits us.

And thus, the first piece focused on pension funds – the article some informed us how effective pension funds can be used in financing productive economic activities in the country.

In arguing the case I gave examples of some of countries that consciously made the decision to reform this sub-sector for the fundamental objective of unlocking the potential savings that can be coordinated, organised better in the form that eventually benefits the whole society.

I went further to indicate the massive size of pension funds globally, pension assets size globally as at the end of 2016 was about $40 trillion, which is about 51 per cent of the projected global Gross Domestic Product (Global GDP is estimated at $78 trillion by end of 2017); in comparison, our pension assets size is Sh11 trillion. This level is still less than 10 per cent of our current or projected GDP – the fact that the global average is 51 percent and we are at less than 10 percent should act as a motivation for us to consider further action in our pension space.

The second piece covered the concept of collective investments (pooled funds), under which I indicated that, much as for us the concept of pooled funds has been in practice in our midst in the past 15 years; however, history records that this vehicle for resource mobilization has been in operations for the past over 200 years in some developed countries, it started from the idea that societies needed to change and become more coordinated on how they can collectively mobilize and manage their individual financial resource more better to achieve bigger and mutual objectives – by pooling their resources together, they reduce their individual investment risks, in the process they become more efficient and through this mechanism they are able to put professional skills into work with the purpose of maximizing investment return in a more specialized manner.

I also indicated that, currently, worldwide collective investment in the form of pooled funds is about $28 trillion, i.e. 36 per cent of global GDP; relative to us – our mutual fund size at Sh250 billion is about 0.25 per cent of our GDP, again another under-utilized opportunity/potential in the manner which we organize and coordinate ourselves under ideas of pooling efforts so that together collectively we can finance our economic development which we promote efficiencies and productivity by demand better returns in our mutual investments. Today’s piece is the continuation of the concept of collective investments/pooled funds, and I will delve into the operability context. Read on:

Collective funds can either be open-ended or closed-ended. Open-ended collective funds are funds that do not have restrictions on the amount/number of shares (or “units”) the fund will issue. If demand is for shares/units is high enough, the fund will continue to issue shares/units no matter how many investors there are; under this arrangement the size of the fund is dictated by the amount of investment in it. The value of the shares is also dictated by the net assets value (NAV) of the fund divided by the number of existing shares. The NAV is defined as the total value of assets of current market value less liabilities – when divided by the number of shares/units the outcome becomes NAV per share/unit.

Open-ended collective funds usually buy back shares from investors when investors wish to sale their share in exchange for money. The most common type of open-ended collective funds are: unit trusts, open-ended investment companies, exchange traded funds (ETFs) and mutual funds. Without going into too details, I will quickly provide a high-level summary of key features for each of these:

Unit Trusts: These are currently operational in our country, and are sold in units, not shares. By way of history about the idea of unit trusts, the first unit trust was issued in 1931 by the company called M&G. In Tanzania, the first unit trust was issued in 2005 by the Unit Trust of Tanzania under their Umoja Fund. Unit trusts are usually administered by a trustee who runs the trust on behalf of its investors, the trust then appoint managers (“fund managers”) and through these fund managers the trustees make sure that the trust is run responsibly.

The value of the units is determined by the market valuation of the securities (assets) owned by the fund, so for example, if the Unit Trust of Tanzania, which runs five funds, have a combined worth of Sh250 billion, and having issued 675 million units -– then one might simply say each unit would be worth Sh370 – but then depends on the assets in which these funds have invested into – the value of units and hence the funds, changes accordingly.

Under open ended arrangements in unit trusts, unit holders, if they wish to liquidate their investment positions, they sell their units back to the manager of the unit trust (i.e. the fund manager, in our case the UTT). The fund manager would then either sell the units to other investors or, if that is not possible because of low demand, the fund manager sells some of the underlying investments to raise cash to redeem the cash to redeem the units. Thus, the number of units changes daily or at least after every few days. There is no secondary market (such as a stock exchange) trading in unit trusts as all transactions are carried out through the trust manager.

Open-ended investment companies: these have recently been introduced in the global financial markets financing vehicles, they were for the first time introduced exactly two decades ago this year, as a more flexible and simpler alternative to existing unit trusts. And since then, many unit trusts have turned themselves into open-ended investment companies. An open-ended investment company can be listed on the stock exchange and it issues shares, whereas a unit trust issues units, not shares.

Furthermore, compared to unit trusts, an open-ended investment company has a simpler pricing system because there is one price for both buyers and sellers. When shares in the open-ended investment company are bought or sold, the share price is the value of all the underlying investments (NAV) divided by the number of shares in issue. As an open-ended instrument the fund gets bigger and more shares are created as more people invest. The fund shrinks and shares are cancelled as people withdraw their money.

Exchange-Traded Funds (ETFs): introduced for the first time in the United States in the 1990s, ETFs take the idea of tracking a stock market index. ETFs are set up as companies issuing shares, and the money raised is used to buy a range of securities such as a collection of shares in a particular stock market index. In our case, one may decide to create an ETF that tracks an index that compose the most liquid assets in our stock market – for example TBL, CRDB, TCC, Voda, NMB, DSE, Swissport, TWIGA, etc. In such an arrangement, if TBL for example comprises 20 per cent of the total value of the index and if the ETF has Sh1 billion to invest it will have to buy 20 per cent of TBL shares. ETFs are open-ended funds – the ETF shares are created and cancelled as demand rises and falls.

However, they differ from open-ended investment companies in that the pricing of ETF shares is left up to the market price. ETFs are listed companies and you can buy and sell their shares at prices subject to change throughout the day (unlike unit trusts and open-ended investment companies, where prices are set by a formula once a day). Despite an ETF’s price being set by trading in the stock market they tend to trade at, or near to, the underlying net asset value (NAV) – the value of the shares making up an index, for instance.

Many countries worldwide have made significant use of these investment vehicles to mobilise financial resources, tapping into idle savings and converting them into tools for financing productive activities within economies; in the process savers and investors, especially the less sophisticated and less savvy indirectly, but beneficially access the financial markets in a manner that maximizes their investment return within acceptable investment risks while enjoying the benefits of professional fund managers. Hopeful we, as a society, may also in some days ahead experiment and experience the same. I will wrap up the topic in the next article.

Mr Marwa is chief executive officer for the Dar es Salaam Stock Exchange PLC.

This article will move to Thursday as The Citizen undergoes a redesigning - Editor