Collective Investment.The More Funds the Better
Editorial
It is only three years since unit investment funds (UIF) were introduced into the Kazakh market, but they have demonstrated a high rate of growth over this period. During 2007 the number of UIFs almost doubled, with Kazakh UIFs reporting a four-fold increase in assets. However, according to traders in the collective investment market, qualitative indicators of such growth, leave much room for improvement.
According to the Financial Supervision Agency, the total UIF assets exceeded 199.5 billion tenge on 1 January 2008 (compared with 48.5 billion tenge on 1 January 2007). The breakdown of UIFs operating in the market is shown in Table 1.
It is easy to see that the majority of new funds are of the close-end type. Not only that, this is the largest group of funds, with assets 56 times higher than those of interval funds (IUIFs) and a whopping 23 times higher than those of open-end funds (OIUIFs). However, this is one of the problems of market growth and an issue which was one of the main topics of discussion at the Second Congress of the Participants of the Kazakhstan Securities Market. This event was held in Almaty in March of this year and organised by the Cbonds Information Agency.
Mr Bakht Niyazov, Chairman of the Board of REAL-INVEST.kz stated that close-end funds and equity funds should not be regarded as methods of collective investment in the securities market, as such funds focus on real estate and direct investments and are instruments for project financing. The composition of the cumulative domestic UIF portfolio confirms this statement and, according to the FSA’s statistics, securities have a less than 20% share of the cumulative portfolio, while investments in equity of legal entities and real estate have shares of 47.8% and 13.1%, respectively. Thus, investment funds which were intended to develop the securities market have actually paid little heed to it.
It is easy to understand that in the current conditions of a protracted financial crisis, OUIFs and IUIFs specialising in securities transactions do not achieve high profits. According to www.investfunds.kz, only 6 out of 17 OUIFs and IUIFs managed to yield a return higher than those from bank deposits during 2007 and only two of them provided a return which exceeded the rate of inflation (18.8%):
1. Damu Invest Open-End Fund, a leader in this sector, achieved an annual return of 47.17%, and
2. Favorit Interval Fund achieved an annual return of 30.36%.
By comparison, the Nasip Interval Unit Investment Fund (leader in 2006) achieved a profit of 87.75% for its unit holders. Unit profitability is a key index for current and potential national investors making decisions regarding UIF investments, which is why they prefer close-end funds with high risks and high profitability.
On the other hand, expert opinion claims that almost 50% of close-end funds are currently used for tax optimisation purposes. Indeed, some are private investment funds which have been established to serve the needs of a specific project and may have only one or two unit holders who are fully exempt from income tax in accordance with the legislation on unit investment funds.
Thus, it is obvious why such ”offshore” activities have become so popular. However, the total number of registered unit holders does not currently exceed 4,500 as UIFs are not investment methods usually chosen by non-expert investors.
Who is at fault and what can be done?
Mr Mukhit Amirbekov, Chairman of the Board of Centras Securities, believes that the current market imbalance results from the legislative limitations applied to no-risk funds (open-end and interval) which prohibit these UIFs from following more aggressive strategies and hence making greater profits.
As a result market players have begun to establish close-end unit funds for high-risk investments and have increased their attractiveness by providing unit holders with an opportunity to withdraw from such funds ”on request” of the management company. Consequently, the concept of close-end funds as a method of fulfilling long-term investment projects was destroyed. Unit holders in close-end funds are theoretically entitled to participate in unit holders’ general meetings and be paid unit dividends in accordance with the fund’s rules. However, unit holders have no authority to require management companies to purchase such units. Instead, such companies have the freedom to sell units independently on a secondary market.
As a result, we have interval funds for high-risk investments which provide unit holders with the same rights as they have in close-end funds. If unit holders have the right to exit from a close-end fund, there is no need to develop a unit exchange trade, as such units could become additional commodities on the securities market.
In this connection, Mr Amirbekov suggests changing the definition of a ”risk fund” in order to extent investment opportunities for open-end and interval unit investment funds. He also suggests prohibiting the exit of unit holders from close-end funds as well as providing a legal definition of retail and private funds, together with an outline of their respective tax benefits.
Taxation issues are a major concern for management companies, who fear the exclusion of UIF tax benefits in a new tax code draft. Wary of the potential risk of funds as a means of tax avoidance, professional market players insist that the performance of UIFs as a method of collective investment is still underdeveloped and that a revised approach is needed.
Retail operations
Open-end and interval funds underwent a stressful period during the third and fourth quarters of 2007. Having previously worked under more stable conditions, management companies were facing sharp market changes for the first time. On the one hand, potential investors had an excellent opportunity to adequately evaluate the competence and qualifications of various management companies but on the other hand unit holders were under severe pressure, which instantly resulted in a decreased volume of investments received. According www.investfunds.kz statistics, the fourth quarter of 2007 saw 24 OUIFs and IUIFs lose a total of 1.158 billion tenge, with the December loss alone amounting to 507 million tenge. Management companies have also seen some investors taking advantage of the market instability by entering UIFs at a very favourable price. As a result, retail funds achieved a positive balance at the year-end with 1,308 million tenge of extra investments. Funds managed by:
· REAL-INVEST.kz (+679 million tenge);
· HALYK Finance (+265 million tenge);
· BCC Invest (+167 million tenge); and
· Resmi (+122 million tenge),
were the market leaders.
In the opinion of professional market players, last year was (in general) unsuccessful for retail UIFs, although there was an increased awareness of these types of investments, which, according to Mr Sergei Lyalin, General Director of CBonds.ru, is confirmed by a doubling of the number of visitors to www.investfunds.kz.
Currently, management companies focus on making corrections to the quality of management strategies and optimising fund portfolios in relation to new market conditions. As Mr Bakht Niyazov points out, liquidity remains the main problem and, with this in mind, many companies transferred a significant portion of IUIF assets to money market instruments and fixed-income securities with some management companies starting to trade more actively with foreign issue securities. According to Mr Talgat Kamarov, Chairman of the Association of Asset Management Companies, approximately 44% of IUIF assets are currently invested in foreign securities. In this way management companies try to extend their asset diversification opportunities which are weak at KASE and the Almaty Regional Financial Centre.
In spite of the measures taken, retail fund assets decreased again during the first quarter of 2008 and, according to www.investfunds.kz, losses amounted to 264 million tenge. It is forecast that the reduction in the number of unit holders will cease by the end of the year when the international equity markets should stabilise.
Market outlook
Experts indicate that a set of additional conditions and prerequisites will be created to develop a sector of collective investments. Management companies have high expectations of a government launch of a new domestic securities market. In addition, given the restrictions on bank credit, so-called ”second echelon” companies will start to use securities on the stock exchange as a funding mechanism, thereby replacing blue-chip companies who have transferred their assets to foreign markets. A positive contribution is expected as a result of the programme to promote investment and financial competence within the population. UIF management companies believe that, under such conditions, novice investors will prefer to invest in UIFs.
Companies have a lot of work to do and areas identified for improvement include the absence of their own retail networks, the narrow range of fund products, weak marketing support, and poorly coordinated activities. According to Mr Kamarov, the initiatives of certain management companies have not been supported and are often ignored by other market participants. “Almost half of management companies are not members of the Association of Management Companies and do not participate in developing draft regulations. Such isolation leads to an increased frequency of inter-corporate disputes.”
It can also be surmised that such disputes arise from the increasingly severe competition for consumers. During the last year, the number of management companies almost doubled as it reached 65. However, investors, who experienced instability in the securities market during the second quarter of 2007, are now more wary when selecting UIFs. Given these conditions, management companies have to extend their product lines and an example of this is Resmi which opened a new interval unit investment fund (RESMI Zarplatny) at the end of February. Having the lowest entry investment requirement (5,000 tenge) is its main competitive advantage. In addition, REAL-INVEST.kz, the largest player in this market sector, stated its intention to establish a retail fund for a wide range of investors. Realistically, there are a large number of potential investors to compete for as Kazakhstan’s economically active population totals more than 7.5 million people. Compared to this potential number, the current 4,500 unit holders are a drop in the ocean.
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