Introduction
Guyana was ranked 104th out of 131 countries for “ease of access to loans” in the World Economic Forum’s “Global Competiveness Report 2007-2008. “Financing through local equity market” did not fare much better coming in at 97th. Indeed after crime and theft “access to financing” was listed as the next most problematic area for doing business. The Diaspora makes a significant contribution to Guyana’s economy by way of remittances. Many more may be willing to support development if given an opportunity to invest via a structured investment. This week I will explore the various forms of investment funds around the world, how they might be used to tap finance from the Diaspora and some of the practical challenges in doing so.
An Investment Fund?
The term “fund” can have a variety of connotations. This immediately raises the challenge posed by differing perceptions. If those financing the fund are not on the same wavelength as those wishing to access the financing then it is unlikely the fund will meet its objectives. A donor expecting a return on his capital will not be a good fit with recipients expecting a grant. Similarly the term investment is often viewed in the economic sense rather than the financial sense. A number of Guyanese businesses carry the name “investment” or “investments” in the title. I suspect such names are appealing more to patriotism than any investment functions in the finance sense of the word. Of course the establishment and upkeep of any business is investment in the economic sense of the word, but by that rationale we could append investment to the names of all businesses which are a going concern.
For the purposes of this article I will define investment fund as “a pool of financing established with the goal of providing an acceptable risk adjusted return on capital through investment in suitable securities.” Note at this point it is worth making the distinction of the primary and secondary market in securities. The primary market is the point at which a security is issued. The secondary market is the market in which title in securities already issued through the primary market can be transferred. A classic example of a primary market is an Initial Public Offering (IPO) where a private company offers its shares to the public for the first time. This will usually be in conjunction with a listing on a stock exchange, providing the secondary market in the shares. Note it is only the primary market which provides investment in the economic sense of the word. A trade on the secondary market in a particular firm does not raise any new financing for the firm – it is merely a transfer of ownership
As we will see the vast majority of investment funds the world over invest in securities through the secondary market (they may also participate in the primary market by purchasing securities if offered to them). However the business of issuing new securities is usually handled by very specialist institutions such as investment banks, private equity and venture capital firms.
Types of Funds
Investment companies have been in existence almost as long as the stock market itself. Indeed the first investment trust (a UK term for a type of investment company, called a closed-end company in the US) was the Foreign & Colonial Investment Trust started in 1868 ‘to give the investor of moderate means the same advantages as the large capitalists in diminishing the risk of spreading the investment over a number of stocks’. At its simplest an investment company is a company whose business is the purchase and sale of stocks and shares in other companies. The company may have specific status under income tax and/or companies acts. The status will largely depend on government policy. A neutral stance would be one under which investing in the investment company does not result in any further taxes compared with holding the shares in which the investment company invests directly.
A feature of such funds is that in order to make an investment one must either subscribe to the initial offering or purchase the shares on the secondary market. Hence in order to cash in on an investment the seller will have to find a purchaser in the secondary market. Typically this will be through trading on a stock exchange. Investment trusts may trade at a substantial discount to the net asset value of the fund which may put off potential investors who may be worried that the discount will widen at the time of cashing in. To combat this effect split capital trusts were established with a fixed windup date on which the property of the fund is distributed. However even these funds have been known to trade at a discount.
Unit trusts (Unit investment trusts in the US) are arrangements where the trustees hold the property of the fund on behalf of the beneficiaries. A manager is appointed to make investment decisions. Unlike an investment trust a unit trust is an open ended vehicle – that is the manager must stand ready to issue new units if there are new subscriptions and must redeem units for cash if an investor decides to cash in. This means that most trusts must be managed with liquidity considerations in mind.
In more recent times far more esoteric funds have developed. Hedge funds are private funds charging a performance fee offering limited participation to qualified investors. Private equity firms structured as limited partnerships to minimise tax liabilities of their partners due to the inconsistent treatment of capital gains and income have come under the spotlight due to the perceived unfairness in the tax treatment.
All of these funds may be classed as collective investment schemes which will usually fall under the regulatory mandate of the securities regulator. Indeed under the Guyanese Securities Industry Act units in a collective scheme including shares in an open-ended investment company are classed as securities and thus require registration before they can be offered to the public.
Challenges of tapping into
the Diaspora
The prospect of tapping into the Diaspora is easier said than done. The first issue is that there are simply not enough secondary market securities available locally. This would mean a fund would need to be involved in at least some primary issue of securities. However the list of incorporated entities with a governance structure likely to be acceptable to such a fund is thin on the ground. Further, there may well be resistance from owners who do not want to see their equity diluted. If the prospects for equity participation are limited then the fund could consider offering loans. Yet we have a banking system which is awash with liquidity. If a business does not qualify for a loan from a bank is it likely that it would be more appealing to a fund? It seems likely that the only opportunities which will readily present themselves are in the area of micro-finance – a highly specialised area and probably the most difficult to administer.
Bearing in mind the likely investment opportunities the structure of the fund itself becomes problematic – neither a closed-end or open-ended structure readily lends itself to microfinance. On the one hand an open-ended fund has liquidity constraints which may not serve the interest of the fund as it could not tie up all its capital in projects. On the other hand a closed fund requires all the financing up front – hardly a suitable way to fund a series of small projects. When you throw in the currency risk associated with small developing countries one has to ask whether it would be appropriate to offer wide participation to investment in such a fund at all.
One must also consider the regulatory burden of operating a fund open to the public. This brings with it all the reporting requirements and the requirement for a prospectus whenever new funds are sought. Unfortunately I do not see a way of marketing a fund to the Diaspora unless it is offered to the public – how else will the Diaspora become aware of it?
Given all the challenges
it will be hard to get a fund off the ground. Nevertheless Jamaica has shown that it is possible to get funding. A recent article published by Micro Capital (http://www.microcapital.org/?p= 1508) describes how the Diaspora community and the United States Agency for International Development (USAID) are partnering to launch a microfinance loan fund for Jamaicans living in inner cities. There may well be scope to approach USAID to see if they will assist in the development of a fund here.
An alternative is for wealthy individuals in the Diaspora to take the initiative to establish funds with fewer participants. Funds with less than 50 participants which have not been offered to the public do not automatically require registration.
Similarly, there are exemptions from prospectus requirements for funding raised from sophisticated investors. This may be the best way forward until Guyana’s capital markets have developed to a point where a fund can be operated through investment in the secondary market alone.