How does one measure the success or otherwise of a product or service? Referring specifically to the Clico Investment Fund (CIF) and based on the comments of Wainwright Iton, chief executive officer of the T&T Stock Exchange, who is quoted as saying that this listing has contributed to "strong and welcome activity" on the TTSE. This is true from a very limited perspective. However, does it represent "success" in a more holistic way?
It was reported that, up to the later part of May 2013, the CIF units saw 1,200 transactions involving 12.6 million units with a total value of $279 million. This works out at approximately $22.14 per unit or almost 11.5 per cent below the NAV of $25.00. While this is good news for traders in terms of commissions earned, unitholders would be concerned about the lower and lower prices that they have received for their holdings.
Could it be that the authorities (Ministry of Finance and/or Central Bank of T&T) may not have gone far enough when they developed and listed the CIF?
Customer profile and tendencies
This product was designed so that holders of the 11-20 year EFPA/Clico bonds would exchange those bonds for CIF Units. The chief disadvantage of the 11-20 year bonds was that, in order to realise immediate cash, they could only be sold at a considerable discount to their face value. This was not an acceptable position for many bondholders.
How many of these unitholders considered that if they decide to sell their units quickly, then they were not likely to receive the full asset value. This is because the greater supply would tend to outstrip demand and cause the price to fall.
A review of the beneficiaries of this fund would suggest that most would not consider themselves as investors. More likely, they are mainly familiar with the basic savings activity of depositing a certain sum of money on which they would earn a fixed rate of interest, be it two per cent or 12 per cent. The possibility that they would or could experience a capital loss was probably alien to almost all of them.
How many of these individuals are familiar with the differences between insured and uninsured deposits? More particularly, what is the difference between deposits (or savings) activities and investing?
Perils of supply and demand vs value
Most open-ended mutual funds tend to trade at or very close to their net asset value. Due to the fixed number of units created for a specific purpose, CIF had to be designed as a closed-end fund and allowed to trade on the stoc exchange.
The urgent need for many unitholders to sell would be much greater than their ability or willingness to wait for the long-term benefits. This reality set the stage for an almost continuous fall in the unit price. Despite the urgings from both the Clico Policyholders Group and the chairman of Republic Bank Ltd, many unitholders continued to sell their holding at lower and lower prices.
So, while the CIF units are a significant improvement over the 11-20-year bonds, the quick sale in which many participated also represented a loss for these former EFPA participants.
What measures could have been implemented to help avert this rapid depletion in value? Could the Securities Dealers Association, the Securities and Exchange Commission and the TTSE have come together and agreed to allow these units to trade within a narrow band and closer to their NAV? Perhaps, this was considered and rejected since it would have been contrary to the operation of "market forces", that is supply and demand. Surely, in special situations, market forces could be "tamed" in order to achieve a greater social, public and economic good?
How would this alternate system have worked in practice? Perhaps, it could have been agreed that trading of these units would follow the system used by the Unit Trust Corporation. The bid price, which corresponds to the net asset value (NAV), would be the price that the seller receives for his unit.
On the other side of the trade is the asked price; this is two per cent higher and would be the price at which the buyer would pay for a unit.
The spread between the two prices would give the broker his commission, thus eliminating the need to charge this as a separate item (and simplifying his administration). For example, if CIF had a NAV of $25 on a particular day, then sellers would receive that price, while buyers would pay $25.50 (two per cent more).
What would be the benefits of this system? The brokers would continue to enjoy a good commission, while the sellers would enjoy better price stability. This is a win-win situation. It is even conceivable that, under this arrangement, brokers could earn a slightly higher rate of commission!
Is a credit union solution possible?
In the context of almost six months of trading activity, this variation or suggestion cannot now be implemented without causing serious disruptions. So, what alternatives might be possible to help mitigate the ill effects of a declining unit price?
The credit union movement is often referred to as the "people's sector." Would they agree to grant loans to these unitholders under the following concessionary terms: (1) Using 100 per cent of the NAV (NOT the share price) of the units as collateral and (2) apply a lower rate of interest, for example, 0.5 per cent on the reducing balance, instead of the customary 1.0 per cent on the reducing balance?
Just as the stockbrokers have gained new clients, the Credit Unions would increase their membership and grow their loan portfolio. Considering that most credit union members also have shares and deposits balances, this would help mitigate any risks. In an era when many lenders are still fighting for good loans with solid security, is this an idea that credit unions can develop and implement to the full?
One possible drawback is that many of the unit holders may not be interested in assuming new loans.
Even so, the loan might be structured as an "interest only" debt. Under this arrangement, the member/borrower would only pay the interest monthly (or quarterly). A few years from now, if the loan becomes non-performing, the credit union can sell the units, probably at a profit, and recover the full amount (or more) on their loan. The implementation of this scheme would require flexibility and innovative thinking.
A less cumbersome option is to have the credit union buy the units from the unitholders at its NAV. They can simply hold on to the units for a couple of years and sell them at a profit. In the meantime, they will earn semi-annual dividends. Again, this would require a variation in the credit union's investment policy together with other administrative approvals.
We should be aware that, in the case of the banking industry, they typically use only 75 per cent of the market value of any traded security as collateral for a loan.
Know your customer
We often hear about the "know your customer" concept, usually in reference to the financial services sector. Essentially, this guideline attempts to restrain representatives of firms (stockbrokers, insurance agents and even lenders) from selling a product that is either unsuitable for the customer or about which s/he does not understand the risks. In other words, it attempts to set a fiduciary standard of care for companies in their dealings with clients.
Could the same standard be applied to either the Ministry of Finance or the Central Bank? Specifically, did they make sufficient effort to anticipate the likely consequences (flaws) when they created the CIF mutual fund product? Would it have been very difficult to anticipate that many former policyholders would want to sell their CIF units as soon as they received the documentation?
Did they develop a profile of the EFPA holders, similar to what financial companies are often required to do, before they foisted the CIF units on to unsuspecting parties? This is a product that was supposed to achieve the government's (implicitly) stated policy to "make whole" policyholders' exposure to a large portion of the EFPA product.
Perhaps, they were trying to transform depositors into investors?
Postscript: In the context of Republic Bank's recent additional investment in HFC Bank in Ghana, one might consider that the price of both Republic Bank's shares and the derivative CIF units could be currently "undervalued".