Long term investments and the reality of policy risk

Zimbabwe’s hyper-inflationary period of circa 2008 pointed long-term investors to the reality of policy risk.

With sectors such as banking, insurance and pensions taking the brunt of the pain.

So, in view of the existence of policy risk (or regulatory risk), how does it interplay with the above sectors’ customers, members and/or policyholders’ reasonable expectation.

Policy risk refers to the risk that unexpected changes to Government regulations and policies will change the investment environment.

On the other hand — at least in insurance law, “policyholders” reasonable expectation’ follow that policyholders are justifiably allowed to assume that an insurer can and will protect the value of their savings.

But how does policy risk and reasonable expectation balance each other out?

Actuary Prosper Matiashe says both arguments can be valid.

“Do policyholders genuinely think they have transferred policy risk when they give their dollar to a pension fund, for example?

“When customers say we have lost value, they typically don’t think Government was complicit. But the sovereign State’s decisions can impact on long-term value preservation,” he told a Zimbabwe Association of pension Funds (ZAPF) conference in November.

“But industry is also complicit in the loss of value due to their decisions. Policyholders reasonably expect (pension) funds to be able to preserve the value of their contributions.

“If we agree that hyperinflation periods are now a trend in Zimbabwe, why do we allow high levels of concentration risk? Foreign investments have become critical in such an environment.”

Policy risk is not uncommon to the investing community anywhere in the world; but it has traditionally been managed by investors through strategic investment, and sometimes — when push comes to shove — with their own internal resources.

Poor regulatory enforcement and demonetisation of the local currency were largely blamed for value erosion by the Justice Smith Commission of Inquiry, which was appointed in 2015 to probe the conversion process.

The Smith Commission came to the conclusion that “there was a huge loss of value to insurance policyholders and pensioners owing to failure by Government, the Insurance and Pensions Commission (IPEC) and the industry to set up a fair and equitable process of converting insurance and pension values from Zimbabwe dollars to United States dollars”.

In a development that highlighted Government’s acknowledgment of the implications of policy risk, Finance and Economic Development Minister Professor Mthuli Ncube announced in the 2021 National Budget that the State would compensate vulnerable segments of society from the value loss that occurred when the country moved to re-introduce the Zimbabwe dollar, from a multicurrency system between 2017 and last year.

The monetary and fiscal authorities have since worked to bring about economic and currency stability, largely through tight spending and the foreign currency auction system.

But companies such as insurance firms and banks, as well as pension funds also still need to acknowledge that they have not been particularly savvy in transferring policy and longevity risk from customers, policyholders and members.

“Zimbabwe Stock Exchange (ZSE) returns are 8 percent of cumulative inflation. So there is no 100 percent matching.

“If we (the pensions sector) had invested all our assets as a sector in equities, we would not have preserved value. And the same applies to properties,” said Mr Matiashe.

Interesting, local pensions funds and insurance firms are still heavily invested in equities and property assets.

Actuary Itai Mukadira and investment consultant Gandy Gandidzanwa say there are still solid investments that can yield good returns even in an inflationary environment.

“A well-blended and balanced, sector-focused, investment strategy could meaningfully hedge their investments against inflation.

“Where the onslaught is from an exchange-rate-driven inflation as it is in our case, the solution is to counter that with an increased allocation to Zimbabwe dollar hedges.

“These are counters on the Zimbabwe Stock Exchange (ZSE) with a significant export orientation whose revenue is generated mostly in US dollar or some other stable currencies. Similarly, there are counters to avoid as well — your ‘Zimbabwe Incorporated’ counters. These are counters that are totally depended on our local consumption propensity and buying power only.

“The establishment of the Victoria Falls Stock Exchange (VFSE) could not have come at a better time. This is a key development that should put smiles on the faces of all serious long-term investors, pension funds included.

“It will bring about such a significant relief to pension funds once it has a sizeable number of listings that makes prudent portfolio construction possible. Trustees should look into gaining exposure into any such portfolios once they become available.”-herald.cl.zw