There is a time when having only one of something is the worst situation, having zero of it being better, and having multiples of it best. This is the case with Exchange Traded Funds (ETFs) in certain market sizes. The foreign exchange rate and ETFs have a relationship! This relationship is not consistent, but has its moments around major events in economic cycles. Over periods of time, correlations can be identified between domestic currency and an ETF that follows the greatest of weight among all the counters in the country. It is the same with indices.
There are important measures that one needs to look at when measuring the risk that any security or group of securities pose to the financial system or to the markets.
There has always been the following questions on Zimbabwe:
1. What drives markets? In other words, what influences the markets?
2. Where there is a black market rate for foreign exchange rate, where does it look to for some form of price discovery?
3. Does a reputation and urgency, added to power mean a stakeholder could drive market sentiment and direction even for a brief moment against what would be otherwise opposing market fundamentals?
Applied to the Zimbabwean situation and contrasted against the chosen exemplar markets, the information below provides insights on market risks from securities and the suitability and validity — let us say the transferability and generalisability of theories and practices we adopt from totally different markets.
1. The S&P 500, market capitalisation (US$31,6 trillion), 68 percent of market capitalisation (US$47 trillion) in the US, is slightly higher than the proportion the ZSE top-10 counters make up of the market value of all Zimbabwean traded securities (53,5 percent).
2. The one ETF on the ZSE top 10 has a Market Cap of 0,04 percent of the ZSE.
3. There are 4 main ETFs in the US for the 68 percent of US market capitalisation and these are stated to have different investment strategies in the top market cap tier counters and different levels of liquidity.
4. There is only 1 ETF for the 53 percent of ZSE equities.
5. The S&P 500 is widely regarded as a true measure of the US economy.
6. The ETFs for the US choose between 500 companies and for the ZSE chooses between 10 or ALL 10.
7. The S&P is full of global companies whose demand and supply chains reach across the globe and which alone can run a conference to compete with Davos. They are big exporters that compete with whole country economies on the S&P 500.
8. The Top 10 ZSE stocks have limited regional or even continental reach in terms of market share, industry leadership, and any Corporate Political Activity outside Zimbabwe.
From the above, the S&P 500 is greatly diversified. While the value trends for the different ETFs closely mirror each other, their disaggregation and independence mean the different entities provide some form of price consensus. Derived valuations of the market or strength of any other security does not become too dependent on market error in tracking the S&P500.
All the above is not mitigated by having a single ETF on the ZSE focusing on the Top 10 counters. The situation instead becomes the foundation of derivative problems. As with major counters’ ETFs, they become the reflection of the market and the economy and start to become a reference point.
Where there is not much trust in reference points, they become a favourite or preferred reference point for certain market players.
It is unfortunate that when market players have previously referred to certain known institutions, gone through some vacuum as they found no other they want to believe, the return of the same institution or its players can be found substantive enough to be the vacuum filler.
It is the worst case scenario of having one of something.
With what ETFs can become in symbolism, Zimbabwe needs a second, if not more ETFs and take a shot at diluting single entities and securities from disproportionately shaping market sentiment, or at worst, providing an erroneous measure of other economic indicators like inflation whilst putting pressure on Forex rates. One only needs to look at performance measures. When ETFs have failed to outperform the whole stock market, some investors have had a different view leading to redemptions.
However, some who are not investors who only look at the performance of a chosen investment strategy then put a value on other economic indicators. A danger of a single ETF in an economic environment is when some key traders are hunting for information that supports their hypothesis or target price.
The different levels of liquidity on the S&P500 ETFs plus the availability of one with lower unit pricing allows greater market participation between large institutions and individual retail investors. The participation of multiple stakeholders means that the multiple ETFs dilute their force of potentially being vehicles for limited interests. It is more difficult to co-ordinate multiple competing entities with varied participants. More ETFs!
We also need to challenge the economic analysis that might become heavily dependent on the biggest counters in the country. Does the ZSE Top 10 really represent the Zimbabwean economy as the S&P500 and its ETFs do the US economy? We are a smaller and less formalised economy. I have previously argued for SPACs to be the conduit of hidden value for all stations that want to calculate the value of Zimbabwe Inc.
I would also argue that greater growth will be found in some of the growing entities in renewable energy. These companies need to be brought faster to the capital markets and securities exchange.
This will be for their benefit and that of the country, having more securities that are linked to country’s value and growth assets. Solar energy, gas exploration and even tourism players are part of the high revenue industries of our economy.
They, however, have poor representation in numbers and proportion. ETFs of our top companies do not, therefore, provide valid indication of our economy.
There is a role for stakeholders to incentivise the companies participating in energy, tourism and construction towards listing. There is benefit to all.
The talk at the recent Capital Markets Awards was about relevance. Relevance can be found in how economic activity connects stakeholders and defines macroeconomic measures and policy.
Players need to target these players coming to the market and through it probably with time have a more diversified Top 10 index. When these companies are on board, they are fuelled for market penetration on the international stage. This growth vector will make our top companies life cycles start to follow trajectories of international players on the S&P500.
The ETFs that cover them will become more indicative of Zimbabwe’s economic power and truer discounted value. This is very important as the AfCFTA takes hold. The one ETF story, however, is opposite to this desirable state of companies that have successfully internationalised.
I believe one ETF that is viewed by stakeholders as more a factorial value to the exchange rate and the inflation equation weakens the relevance of the security.
The risk around one ETF being misconstrued as what it is not or as a determinant of macroeconomics can only be mitigated by having more ETFs. We should have more ETFs for top counters where the diversification is improved by more participants from areas of the nation’s value chains listing. The Government has a role to play too.
Some SOEs could easily be permanent residents of the Top10 counters. Privatisation and part-privatisation needs consideration to clear conclusions and implementations.
As such entities enter clear public view, even those wishing to derive forex rates from associated ETFs will only be finding themselves closer to a truer gauge of the economy.