If you are invested in any financial asset in Ghana then it is likely that you have been following every development with keen interest. With significant reforms in the fund management industry and a banking sector overhaul occurring within the last 5 years, one would have thought that the turbulent times in the industry were behind us. On the contrary, the past 10 months or so have been among the most challenging for the industry in recent memory. Runaway inflation, a deterioration in the state of public finances, and a sharp depreciation of the currency has chipped away at the assumption that one would always receive the money they lend to the government. And panic levels are higher than they’ve been in a generation.
From around June this year, there were rumours that fund managers were struggling to meet redemptions as investors were withdrawing their monies while cutting off the flow of new deposits. At that point it had less to do with any fear of debt restructuring and more to do with a reallocation of funds by investors who had seen treasury bill interest rates rise from 12.5% in January to 25% by mid-year, and were trying to get their money out of funds who were invested in long-dated bonds and were thus returning a lower rate of interest. Things got worse when news of possible local debt restructuring broke out on Bloomberg and the panic reached a fever pitch as investors rushed to take out their monies.
In response, the Securities and Exchange Commission (SEC), has issued a directive to fund managers to “use the mark-to-market valuation method in the valuation of investment assets / securities and portfolios in the securities sector“. In this post I am going to explain what this means in the simplest possible terms and explain the implications to investors.
How Assets used to be Valued
When you get your statement from your fixed income mutual fund/unit trust manager, it is likely to show all the total deposits you have made, the accrued interest on it, any withdrawals you have made, and then your amortized balance which is simply your deposits + interest – withdrawals. The interest that you earn is determined by the face value and interest receivable on all the investments that the fund is currently holding. Let me quote an article I wrote in 2017 on mutual funds to explain how this works.
“Because a mutual fund invests in other securities, its value depends on the value of the securities it invests in. At any point in time, the price of a share in the mutual fund is the value of the net assets (the value of all its assets less any liabilities) of the fund divided by the total number of shares of the fund. The returns from securities held by the fund, such as interest or dividends are usually re-invested in the fund to drive up the price of the fund’s shares. So for an investor in a mutual fund, you gain when the price of the shares rises and lose when it falls.“
Let’s not get too bogged down in the technicality of the valuation. What you need to know is that in normal times, fund managers expect that they will hold the assets they hold until the maturity date or they will be able to sell the asset at a price close to the face value of the asset. This is because the overwhelming majority of funds are loaded with fixed income products like treasury bills, government bonds, notes, ESLA bonds and corporate bonds. If it were an equity fund (a fund invested in listed companies on the stock exchange), they would necessarily have to revalue the assets based on prevailing share prices on the market. However, this was not considered necessary for fixed income products. Therefore, they value your money invested with them on the assumption that they will receive the money they have invested in the assets as well as any interest due on those assets.
What has Changed?
Kindly bear with me as I get a little technical here, but you will certainly understand by the end. Bonds are issued with a face value (the principal), a coupon rate (interest rate you will get paid periodically), and a maturity date (the date you will be paid the principal). The easiest way to understand this is by seeing it as a contract. For example, Madam A has lent her Old Students’ Association funds of GH¢1,000 to Madam B with an interest rate of 10% payable annually for 5 years. This means Madam B pays Madam A GH¢100 every year for 5 years and then returns the GH¢1,000 to Madam A at the end of the fifth year. Simple enough. Now let’s say that 2 months into the agreement, Madam C goes to Madam A and asks for GH¢1,000 at an interest rate of 20%. All of a sudden, Madam A is eager to get out of her contract with Madam B and enter a contract with Madam C in order to benefit from a higher interest rate. She is therefore willing to accept a compromise payment from Madam B in order to get out of that contract early and enter a new contract with Madam C. Clear so far? Great.
Now let us assume that Madam B refuses to void the contract. Madam A is therefore on the lookout for somebody to give her some money in exchange for the person receiving the rights to the contract with Madam B. However, nobody is willing to offer her any reasonable price and if she wants to void the contract, she will have to receive a price far below what she would have got by just holding on to the contract. Got it? I hope so. Madam A therefore decides to keep the contract with Madam B as the best course of action. Meanwhile, members of the Old Students’ Association have been demanding that Madam A pay them their monies as they are unimpressed with the contract she signed.
In this illustration, the mutual funds are Madam A and most of the bonds they are holding are the contract signed with Madam B. Madam C’s offer are the current bonds with better interest rates in the market, and nobody is willing to buy the bonds the funds are currently holding unless at a very bad price. The members of the Old Students’ Association are obviously you, the investor in the mutual fund. The funds are in a bind because they are being forced to accept poor prices to get rid of the current bonds they are holding in order to pay off customers. Meanwhile the objective of the fund is to convince investors to wait for the bonds to mature so that they can pay them in full.
What does Mark-to-Market Mean?
Let’s go back to the illustration used. Let’s say that in response to pressure from the Old Student’s Association, Madam A decides to accept GH¢800 in cash in order to terminate her contract with Madam B. She would have lost GH¢200 on the principal as well as all the interest she would’ve earned if she had waited for the contract to mature. Also, she would only be able to return GH¢800 to members instead of their initial GH¢1,000. For members who come first, they will get their money in full. But those who come later would not be able to get anything at all.
In order to avoid this situation, Madam A decides to tell members that their investment is now worth only GH¢800 if she decides to pay them back now. But if they wait, they will get their full returns. In order that no member gets to take their full funds while others get nothing, she says that anyone who decides to pull out will only get 80% (GH¢800/GH¢1000) of their funds. And this is the idea of mark-to-market value. It is simply changing the value of your funds from how much you deposited and the interest receivable on it to how much you would get if the fund manager was to wrap up and sell off all the assets to pay you back. Your funds with mutual funds now reflect the current prices of bonds in the market.
What can I do as an Investor?
Now in any other climate, this issue of revaluing assets to reflect their current market value should be standard. But the issue has been complicated by concerns of government’s solvency and a lack of information about what exactly government’s plan for restructuring is. The government has set up a 5-member committee “to lead the financial sector stakeholder engagements to reach a deal with the International Monetary Fund (IMF) in Ghana’s debt restructuring.” The President in his address on October 30 also said that there will be no haircuts.
“I also want to assure all Ghanaians that no individual or institutional investor, including pension funds, in Government treasury bills or instruments will lose their money, as a result of our ongoing IMF negotiations. There will be no “haircuts”, so I urge all of you to ignore the false rumours, just as, in the banking sector clean-up, Government ensured that the 4.6 million depositors affected by the exercise did not lose their deposits.”
Without a simple, unambiguous statement on what the plan with government bonds will be, there will continue to be uncertainty and anxiety both among customers and the fund managers themselves. Investors should consider requesting their statements and calling up their fund managers for insight into what they believe a debt restructuring would entail, how much they could lose, and whether it would make sense to close out your investment now and take the loss. Your course of action would depend on your particular circumstances and therefore it is always important that you speak with a financial advisor before you take action.
If you have found this post useful, kindly share as I’m sure many people are seeking clarification on this matter. And if you have further questions, you can check out this FAQ on the SEC website. You can also leave a question in the comments or send me an e-mail. Thank you for reading.