Developing the Buy Side

January 2017Jacqueline Irving, John Schellhase, and Jim Woodsome

CapitalMarketsintheEastAfricanCommunity:DevelopingtheBuySide

ApaperpreparedbytheMilkenInstituteCenterforFinancialMarkets

ThispaperwaspreparedbyJacquelineIrving,director;JohnSchellhase,associatedirector;andJimWoodsome,seniorassociatewiththeMilkenInstituteCenterforFinancialMarkets(CFM).TheauthorswouldliketothankStaciWarden,executivedirectorofCFM,forguidanceandcomments.

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TableofContents

Acknowledgments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3

I . Overview .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4

I I . L iterature review .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5

I I I . Taking stock of EAC pension fund and insurance sectors: Current context . . . . 7 Demographicsandlabormarkets.............................................................................................................7Privateschemesandtheshifttodefined-contribution............................................................................8Theuseofexternalfundmanagers..........................................................................................................9Insurancecoverage.................................................................................................................................10Deepeningassetpools............................................................................................................................10

IV. Drivers of asset al location by institutional investors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 A.Nationalregulatoryconstraints..........................................................................................................13

Nationalceilingsbyassetclass......................................................................................................14B.Driversofassetallocation:Theoryvs.empiricalfindings...................................................................18

Pensionfundshavediversifiedawayfromcashanddeposits......................................................20Holdingsinshort-termgovernmentsecuritiesfallbelownationalandeveninternalceilings.....20Pensionfundholdingsingovernmentbondsaresizablebutbelowceilings................................22Verylimitedcorporatebondholdingsreflectsmallmarketsize...................................................24Pensionfundsholdmuchmorethaninsurersinlistedequities....................................................26Investorsgenerallyholdverysmall,ifany,amountsinunlistedequity........................................27Overalldiversificationawayfromrealestate................................................................................28

C.Assessingcapacityforexecutinginvestmentstrategy.......................................................................31ITandhumancapacity...................................................................................................................31Capacitytoassessrisks..................................................................................................................32

V. Cross-border asset al location and its drivers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35 A.Regulatorylimitsonintraregionalandothercross-borderinvestment.............................................36B.Internalguidelinesoncross-borderinvestmentswithintheEAC......................................................37

Availabilityofcurrency-hedginginstruments................................................................................39ActualforeignallocationofEastAfricaninvestors........................................................................40

VI. The buy side for Rwanda: How can Rwanda’s capital markets attract institutional investors across the EAC? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43

A.WhatstopsinvestorsattheRwandanborder?..................................................................................44B.WhatmakesRwandaattractivetoinvestors?....................................................................................46C.InvestorappetiteforincreasinginvestmentsinRwanda...................................................................49

VII. Conclusions and policy implications . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 53

Addendum: Highlights from a roundtable discussion on developing capital markets, 2016 Milken Institute London Summit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 58

References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60

About Us . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 64

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AcknowledgmentsWewouldliketoextendourgratitudetothemanypeoplewhomadethisstudypossiblethroughtheirguidance,knowledgeandinsights,andsupport.

Severalpeoplesharedinsights,guidance,comments,andotherfeedbackthathelpedhonethestudy’sfocus,design,andfindings.WewouldliketothankDavidAshiagborandStefanNalletamby(bothoftheAfricanDevelopmentBank);GerardCaprio(MilkenInstituteandWilliamsCollege);SiobhanCleary(WorldFederationofExchanges);MichaelFuchs;AnaghaHunnurkar(RwandaNationalInvestmentTrust);KeithKalyegira(UgandaCapitalMarketsAuthority);RobertMathuandEricBundugu(RwandaCapitalMarketsAuthority);NicodemusMkama(TanzaniaCapitalMarketsandSecuritiesAuthority);PaulMuthauraandLukeOmbara(KenyaCapitalMarketsAuthority);EvansOsano(FSDAfrica);JohnBoscoSebabi(RwandaSocialSecurityBoard);andFionaStewart(WorldBank).

Wewouldalsoliketoacknowledgethepeoplewhohelpedusbuildthesurveysample,aswellasthosewhohelpedusbetterunderstandthelocalregulatoryenvironment.Theirassistanceandinsightswerecriticaltothesuccessfulimplementationofthesurvey,aswellastosubsequentanalysisofthefindings.DavidAshiagbor,coordinatorofMakingFinanceWorkforAfrica,directedustoseveralin-countrycontactsforessentialdataandinformationandprovidedusefulinsights.WealsothankJustusAgoti(KenyaCapitalMarketsAuthority);BenKipanga(KenyaRetirementBenefitsAuthority);FredericNtimarubusa(EastandCentralAfricaSocialSecurityAssociation);NoellaMurigoandCarineTwiringiye(RwandaCapitalMarketsAuthority);BonifaceMutabazi,BonaventureSangano,andRogersNuwagiraBukoni(NationalBankofRwanda);IreneIsaka,MohamedNyasama,andCarinaWangwe(TanzaniaSocialSecurityRegulatoryAuthority);SamwelMwiru(TanzaniaInsuranceRegulatoryAuthority);MiriamMagala,FaithEkudu,andJaneKawuki(UgandaInsurersAssociation);JosephLutwama(thenoftheUgandaCapitalMarketsAuthority);BenjaminMukiibiandCosmasSsenyonga(UgandaRetirementBenefitsRegulatoryAuthority);andProtazioSandeandBenerdObel(UgandaInsuranceRegulatoryAuthority).

MilkenInstituteinternsChristopherBensonandAtulMenonwereinstrumentalinfieldingthesurveyandcontributingtoresearchandanearlydraftofanoteontheregulatorycontext.InternDylanClementassistedwithdatacollection.VanessaTaylorprovidedassistancetotheauthoringteam.LauraDominickeditedthereport.HeatherFieldscoordinatedproductionandcoverdesign.

Finally,theauthorswouldliketothankStaciWarden,executivedirectorofCFM,forherguidanceandfeedbackthroughouttheproject.

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I.OverviewDeep,liquidcapitalmarketsarefundamentaltoeconomicgrowthbecausetheyhelpchannelthedomesticsavingsofanationtotheirmostproductiveuses,andinsodoingenabletheprivatesectortoinvest,produce,andcreatejobs.Butwhilemuchworkhasbeendoneonimprovingtheinvestmentclimateindevelopingcountriesforinstitutionalinvestors,lessworkhasfocusedontheinstitutionalinvestorsthemselves.However,acrucialstepindevelopingcapitalmarketsistodevelopthedomestic“buyside”—thatis,toencouragegreaterparticipationoflocalandregionalinstitutionalinvestorssuchaspensionfundsandinsurancefirmsindomesticcapitalmarkets.Mostfundamentally,theselargepoolsofsavingscanevolveintoimportantsourcesoflong-termfinanceforeconomicgrowth—forinfrastructure,forexample.Inaddition,awell-functioningbuysidereducesaneconomy’srelianceonforeignportfolioinvestors,increasingmacroeconomicresiliencetoshockscausedbysuddencapitalinflowsandoutflows.

Policymakersindevelopingcountries,however,mustfindaregulatorybalancethathelpsenablethedevelopmentofthebuysideintoaforceforcapital-marketdeepening,financialstability,andlong-termfinancewhileatthesametimeupholdingthefiduciaryrequirementsoftheseinstitutionstoprotectthesavingswithwhichtheyhavebeenentrusted.Tofosterthiskindofbalancedregulatoryregime,itisfundamentalforregulatorstounderstandhowdomesticinstitutionalinvestorsrespondtoregulatoryandotherincentives.Inordertoaddressthisquestion,weundertookacomprehensivesurveyofbuy-sideinstitutionsbasedinKenya,Rwanda,Tanzania,andUganda—focuscountriesforourstudyintheEastAfricanCommunity(EAC).1Participatingfirmsaccountedforjustunderhalfoftotalassetsundermanagement(AUM)bytheinsuranceandpensionindustriesinthesecountries.Throughquestionnairesandinterviewswithkeydecision-makersinassetmanagementandnationalregulatoryauthorities,2wesoughttounderstandhowinstitutionalinvestorsmanagetheirportfolios,thefactorsthatinfluencetheirdecisions,andthehurdlestheyfaceintakingamorediversifiedportfolioapproach.Weusedtheseevidence-basedfindingstoidentifyareasforpotentialpolicyandregulatoryreformthatcanachievethedualobjectivesofencouragingdeepercapitalmarketsandsourcesoflong-termfinanceandensuringthatlong-termsavingsareprudentiallymanaged.

WefoundthattheEAC’sinstitutionalinvestorbaseisgrowingrapidlybutthatitsabilitytocontributetolocalandregionalcapital-marketdevelopmentcanlikelybefurtherenhanced.Withrespecttoinvestmentsacrossvariousassetclasses,manypensionfundsandinsurancecompaniesstillallocatesubstantialportionsoftheirportfoliostogovernmentsecurities,realestate,andbankdeposits.Lowallocationstoprivate-sectorsecuritiesdonotreflectalackofdemand,butratherahostofotherfactors,includingregulatoryrestrictions,conservativeinternalinvestmentguidelines,internalcapacitylimits,andalackofinvestableproduct—allofwhichcanbeaddressedovertimethroughacombinationof

1ThispaperfocusesontheEACmemberstatesthathavelocalcapitalmarkets.2Morespecifically,thestudymethodologyfocusedonamixofdataandinformationcollectionthroughasurveyinstrument,semi-structureddiscussions,andcanvassingavailabletimeseriesdatafromcapital-marketregulatorsandothersecondarysources.Asafirststeptohelpinformdevelopmentofourquestionnaire,wehelddiscussionswithkeystakeholdersintheprivateandpublicsectorsinthefocuscountriesandwithothercapital-marketexperts.

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prudentregulatoryreform,capacitydevelopment,andtheintroductionofnewinvestmentproductsthatmeettheneedsoftheseinvestors.

Withrespecttocross-borderinvestments,wefindthatinspiteoftheEACCommonMarketProtocol,someinvestors,notablyinsurancecompanies,arerestrictedintheirabilitytoinvestthroughouttheEAC.However,evenwhereinvestorsareallowedtoinvestacrosstheregion,manydonot,eitherbecauseofmisperceptionsaboutwhattheregulationsdoanddonotalloworaninabilitytomanageforeignexchangerisk.Toencouragegreaterintraregionalinvestment,regulatoryclarityandharmonizationareimportant,asisthedevelopmentoflocalhedginginstruments.

Thispaperisorganizedasfollows:Inthefollowingsection,SectionII,wesurveytherelevantliteratureonthelinkbetweeninstitutionalinvestorsandcapital-marketdevelopment,withparticularattentiongiventoinstitutionalinvestorsinsub-SaharanAfricaandtheEAC.InSectionIII,weprovideimportantcontextualfactors,suchasdemographicandlabormarketcharacteristics,thatinfluencetheinsuranceandpensionindustries.InSectionIV,weexaminehowtheseinvestorsmanagetheirportfolios,includingtheregulatory,capacity,andotherfactorsthatinfluencetheirabilitytodiversifyacrosslocalassetclasses.Inthesamesection,weexaminewhereinstitutionalinvestorsactuallyallocateassetsandhowthisstacksupagainsttheirinternaltargets,aswellasregulatoryrestrictions.InSectionV,welookatwhetherfirmsdiversifytheirportfoliosbeyondtheirdomesticmarketsandwhatbarrierstheymayfacetodoingsofurther.SectionVInarrowsthecross-borderfocustoexaminehowasmall,underdevelopedcapitalmarketsuchasRwanda’scandrawonitsintraregionaltiestoattractinstitutionalinvestorsthathaveaccumulatedlargeassets.Rwanda’sgovernmenthasrecentlyembarkedonamajorinitiativetodevelopitscapitalmarkets,andsoitisappropriatetogivesomeadditionalattentiontohowthismarketmightexpanditsinvestorbase.Finally,SectionVIIsummarizesourfindingsanddrawspolicyimplicationsinformedbyevidencefromthisstudy.

II.Literaturereview

Agrowingbodyofresearchhasexaminedhowandunderwhatconditionslocalinstitutionalinvestorsmaycontributetocapital-marketdevelopment.Thisresearchhasfocusedmainlyoncontractualsavingsinstitutions—pensionfundsand,toalesserextent,lifeinsurancecompanies.3AsCatalan,Impavido,andMusalem(2000)pointout,contractualsavingsinstitutionsarespecialtypesoffinancialintermediariesbecausetheirinvestorscannotliquidatetheiraccountsatwill.Assuch,contractualsavingsinstitutionstendtohaveliabilitiesthatarelong-term.Theoretically,theyarewell-suitedtoinvestinginassetswithsimilarlong-termmaturitiesandwithlessriskofunexpectedliquiditydemands.Accordingtothislineofreasoning,contractualsavingsinstitutionscanprovideastablemarketforissuersoflong-termsecurities.

Severalstudiessincethe1990shaveestablishedanempiricallinkbetweencontractualsavingsinstitutionsandcapital-marketdevelopment.James(1997),forexample,observedthatinChile,localfinancial-marketliquidityincreasedaspensionfundsdiversifiedtheirportfoliostoincludemore

3Othertypesofinstitutionalinvestors,suchasgeneralinsurancecompaniesandmutualfunds,havereceivedlessattentioninthesecondaryliterature.

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marketablesecurities.UsingdatafrombothOECDandnon-OECDcountries,Catalan,Impavido,andMusalemfoundthatcountrieswithlargercontractualsavingssectorstendedtohavelarger,moreliquidstockmarketsandthatthisrelationshipheldfordevelopedaswellasdevelopingcountries.Thisstudyalsolinkedgrowthincontractualsavingswithgrowthinstockmarketcapitalizationandturnover.InastudyfocusedonLatinAmericancountries,WalkerandLefort(2002)showedthatpensionreformledtoadecreaseinthecostofcapitalforfirms,aswellaslowersecurity-pricevolatility.Similarly,Impavido,Musalem,andTressel(2003)showedthatstockandbondmarketsdeepenedastheshareoffinancialassetsheldbypensionfundsandlifeinsurancefirmsgrew.

Researchershaveproposedanumberoftransmissionchannelsthroughwhichlocalinstitutionalinvestorscouldcontributetodomesticcapital-marketdevelopment.Inadditiontobeingastablesourceofdemandforlong-termsecurities,institutionalinvestorscanspurfinancialproductinnovationandadoptionofmoreefficientmarketpracticesbydemandingproductsandservicesthatmeettheirinvestment,trading,andrisk-managementneeds.AccordingtoWalkerandLefort,institutionalinvestorspromotedlocalintroductionofzero-couponindexedbondsinChile,aswellasmutualfundsandsecuritizedinstrumentsinArgentina.Inthesamestudy,theauthorsdescribedhowthegrowthofinstitutionalinvestorscatalyzedtheestablishmentofmarketmakersinArgentina,aswellasthetransitiontoelectronictradingandcustodyinChile.

Institutionalinvestorsalsocontributetofinancial-sectordevelopment,accordingtoVittas(1998),byactingasadvocatesforhigherobservedstandardsofcorporategovernance,accounting,transparency,andprotectionofminorityshareholders.Furthermore,aWorldBankstudy(2001)emphasizedthatinstitutionalinvestorscandrivelearningandhuman-capitaldevelopmentamonglocalmarketparticipants.Institutionalinvestorsbenefitfromsignificanteconomiesofscale,whichfacilitateprofessionalizationandgreaterspecialization.

Researchhasalsoshown,however,thatthesebenefitsdonotaccrueautomatically.Vittas(2000)arguedthatwhilesuccessfulpensionreformrequiresastablemacroeconomyandfinancialsystem,aswellasaneffectiveregulatoryregime,severaladditionalconditionsmustbemetforpensionfundstocontributetocapital-marketdevelopment.Theseconditionsincludecriticalmassintermsofassets,adiverseinvestorbase,andproperincentivesforfundmanagerstooptimizetheirportfolios.RaddatzandSchmukler(2008)foundthatifincentivesaremisaligned,fundmanagerstendtoinvestmoreconservatively,orexhibitgreatershort-termism,thanisoptimalforlonginvestmenthorizons.

Theliteratureontherelationshipbetweeninstitutionalinvestorsandcapital-marketdevelopmentinsub-SaharanAfricaislessdeveloped.In2007,theWorldBanklinkedpensionfunds’then-poorinvestmentreturnsinKenya,Tanzania,andUgandawithundiversifiedportfolios,partlyduetorestrictiveinvestmentpolicies,includingintraregionally.Dominatedbygeneralinsurance,theinsurancesectorsinallthreecountrieswerecharacterizedbycomparablylowpenetrationrates,owingtolackofawarenessandhighcosts.Thereportconcludedthatthesesectorswouldbenefitfromregionalizationandbeingallowedtoinvestacrossborders.Inafollow-upstudy,Wagh,Lovegrove,andKashangaki(2011)reportedthatthemaininvestorsinEACcapitalmarketswereinstitutionalinvestorsandthatKenyaninvestorswerepredominant.

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InamorerecentsurveyoftheEAC’spensionsector,CallundConsulting(2013)concludedthatvirtuallyallthemajorEACpensionfundshadmarkedlyimprovedtheirowngovernanceandoperationsinrecentyearsandthatthesectorwas“clearlymovingintherightdirection.”4However,itsreportnotedcontinuingweaknesses,includingpoliticalinterferenceand“acombinationofoftenhighinflationratesandlimitedchoicesforinvestment[which]leadstolowratesofreturn.”Thereportalsonotedthatregionalintegrationwouldbenefitthepensionsectorbyexpandinginvestmentoptions,particularlyifEACmembersweretoharmonizetheirinvestmentguidelines.Mostrecently,aWorldBank(2015)assessmentofRwanda’sfinancialsectoremphasizedthecriticalimportanceofregionalintegration,giventhatthepooloffundsacrosstheEAC,especiallyinKenya,exceedswhatasmalleconomysuchasRwanda’scangenerateinternally.

III.TakingstockofEACpensionfundandinsurancesectors:CurrentcontextIngeneral,thepensionfundandinsuranceindustriesinEastAfricaarecharacterizedbylowparticipationrates.Despitedemographictailwinds,lowlevelsofformal-sectoremploymentremainabarriertoaccesstoretirementbenefitsforlargesegmentsoftheregionalpopulation.Thoughlarge,state-runschemesstilldominatethepensionindustry,hundredsofprivate,employer-basedschemeshavebeenestablishedinafewcountriesinrecentyears,adevelopmentthathascontributedtotheriseofaprivateasset-managementindustry.Privateschemes,followingalargertrendthroughoutAfrica,areincreasinglydefined-contribution(DC)asopposedtodefined-benefit(DB).Atthesametime,aninsuranceindustryhasalsobeengrowing,thoughinsuranceproductsremainoutofreachformany.Still,despiteobstacles,thepoolofassetsmanagedbypensionfundsandinsurancefirmshasincreasedinrecentyears,withAUMnearlydoublingsince2011.

Demographicsandlabormarkets

YouthfulpopulationsandstrongeconomicgrowthholdpromisingpotentialtobuoythedevelopmentoflocalpensionandinsurancesectorsacrosstheEAC.Fertilityrateshavebeendecliningbutremainhighbyworldstandards.Atthesametime,lifeexpectancies,asshowninTable1below,haveimprovedthankstopublichealthadvancesandsteadyeconomicdevelopmentgainsinthesecountriesoverthepastdecadeorso.However,bothpensionandinsurancecoverageremainlimitedintheEACfocuscountries,evenKenya.Only11percentofKenya’spopulationparticipatedinapensionschemein2013.5InRwanda,theRwandaSocialSecurityBoard(RSSB)coversonlyabout8percentofthepopulation,whileonerecentstudyestimatedthatonly1percentofUgandanscontributetotheircountry’sNational

4CallundConsulting(2013),“ReviewoftheStructureofthePensionSectorintheEAC”(London:CallundConsulting).5FSDKenya(2013),“FinAccess:NationalSurvey2013”(Nairobi:FSDKenya).

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SocialSecurityFund(Uganda-NSSF).6Meanwhile,just17percentofKenyansuseinsuranceproducts,alongwith13percentofTanzanians,9percentofRwandans,and2percentofUgandans.7Currentlabormarketdynamicsposeoneofthemostseriousobstaclestodevelopingtheinstitutionalinvestorbaseinthesecountries.Inasurveyofpensionsectorsin15Africancountries,forexample,StewartandYermo(2009)observedthatmostfundscoveredworkersonlyintheformalsector,yetalargemajorityofpopulationswereemployedintheinformalsector.AcrosstheEAC,participationinpensionprogramsiscommonlyavailableonlyviaformalemployment.Thefactthatlargesegmentsofthesecountries’populationsworkintheinformalsectorlimitsthepoolofsavingsavailableforinvestment.InKenya,forexample,jobsintheinformalsectorrepresent83percentoftotalemployment.InRwanda,theinformalsectorconstitutes68percentoftotalemployment.8InUganda,95percentofworkersages18to30—preciselythoseworkerspolicymakershopewillpayintotheretirementbenefitssystem—areemployedinformally.9Atthesametime,officialunemploymentratesare9.3percentinKenya,13.2percentinRwanda,10.3percentinTanzania,and9.4percentinUganda.10

Privateschemesandtheshifttodefined-contribution

ManyAfricancountries’pensionsectorsremaincharacterizedbydominantmandatorystateschemesandmuchsmallerprivatepensionschemes,ifthelatterexistatall.Reformsareunderwaytoextendpensionbenefitstoalargershareofpopulationsandputinplacemoreself-financingschemes.Thenumberofformal-sector,employer-sponsoredpensionschemeshasbeengrowing,particularlyfollowingtheestablishmentofdedicatedretirementbenefitregulatoryauthorities.(SeeSectionIVforadiscussionofregulatoryreforms.)Privatelymanagedfunds(occupationalschemes)playarelativelylargeroleinKenya’ssystem,wheretheRetirementBenefitsAuthority(RBA)nowlistsnearly2,000privateschemesasregisteredmembers,doublethenumberfromadecadeago.Ugandahasalsoseenanincreaseinthenumberoftheseemployer-basedschemes.TheNationalBankofRwanda(BNR)recentlyannouncedthatitwouldbeginlicensingprivatepensionschemesinmuchthesameway

6CallundConsulting(2013),“ReviewoftheStructureofthePensionSectorintheEAC”(London:CallundConsulting);EconomicPolicyResearchCenter(2013),“UgandaFinscopeIII:SurveyReportFindings”(Kampala:EconomicPolicyResearchCenter).7FSDKenya(2013),“FinAccess:NationalSurvey2013”(Nairobi:FSDKenya);FinancialSectorDeepeningTrust(2013),“FinscopeTanzania2013”(DaresSalaam:FinancialSectorDeepeningTrust);AccesstoFinanceRwanda(2016),“FinancialInclusioninRwanda2015”(Kigali:AccesstoFinanceRwanda);andCarpenter,Richard,LisaBeichl&RolandSteinmann(2013),“MicroinsuranceinUganda:CountryDiagnosticReportonMarketandRegulations”(Frankfurt:DeutscheGesellschaftfürInternationaleZusammenarbeit).8NationalInstituteofStatisticsofRwanda(2016),“LaborForceSurvey2016:Pilot.”9UgandaBureauofStatistics,“StatisticalAbstract2015”(October2015).10TheKenyanfigurerefersto2015andisproducedbyInternationalLaborOrganizationemploymentmodels.Theotherfiguresderivefromnationalstatisticsinstitutes,asreportedin“LaborForceSurvey2016:Pilot,”NationalInstituteofStatisticsofRwanda(June2016);“IntegratedLaborForceSurvey2014:AnalyticalReport,”NationalBureauofStatisticsofTanzania(November2015);and“StatisticalAbstract2015,”UgandaBureauofStatistics(October2015).Interestingly,theRwandanreportnotesthatifemploymentweredefinedtoincludepersons“engagedwhollyormostlyinsubsistencefoodstuffproduction,”theunemploymentratewouldbe2.8percent.Thisrecalculation,however,wouldnotsignificantlyaffectthedevelopmentofinstitutionalinvestorsinRwanda,asthiskindofemploymentwouldnotincludeparticipationinanorganizedpensionscheme.

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KenyanandUgandanregulatorsdo.11InsurersinRwandaalreadymanageabout50privatepensionschemes.

TABLE 1. Selected demographic indicators in the EAC

Fertilityrate(childrenperwoman)

Medianageofpopulation(years)

%ofpopulation

Lifeexpectancy(years)

0-24yearsofage

25-49yearsofage

2000 2015

Kenya 4.4 18.9 61.4% 29.4% 51.9 60.6Rwanda 4.1 19.2 60.4% 29.7% 44.4 63.1Tanzania 5.2 17.3 64.4% 26.3% 49.1 64.0Uganda 5.9 15.9 68.4% 24.4% 44.5 57.3

Worldwide 2.5 29.6 42.3% 35.3% 65.6 70.5Source:UnitedNations,DepartmentofEconomicandSocialAffairsPopulationDivision,“WorldPopulationProspects:The2015Revision”Overthepastdecadeorso,therehasbeenanoverallshiftinAfricaawayfromDBandtowardDCpensionschemes.12AmongthechallengesfacingpensionsystemsintheEACandotherAfricancountries,however,isthatDBschemesarecostlyandmaybeunderfunded,posingagrowingfinancialburden,whileDCschemestendtobesmallinnumberandassets.13WhileDCschemesareviewedaslesscostly,moretransparent,andeasiertomanageoverall,theyshiftthepensioninvestmentriskfromtheemployertothecontributingemployee.Intheabsenceofeffectivebenchmarksandincentives,thiscanplacethefocusofpensionproviders,employees,andregulatorsmoreontheshorttermratherthanthelonger-termgoalofensuringthefundpaysoutanadequateretirementincome.14

Theuseofexternalfundmanagers

Theproliferationofsmall,employer-basedschemeshasgivenrisetothegreateruseofexternalfundmanagers,sincemanyoftheemployer-basedschemeslacktheinternalcapacitytomanagefinancialportfolios.TheUgandaRetirementBenefitsRegulatoryAuthorityhaslicensedsixsuchfundmanagers,andinKenya,20externalfundmanagershavebeenlicensed.TheKenyanmanagersrangegreatlyinsizeandsophistication,someservingonlyahandfulofclientswhileothersserveover300smallschemes.15

11TheNewTimes,“BNRtoStartLicensingPrivatePensionProvidersNextMonth”(September29,2016).12Inastudyonthefinancialsystemsof24AfricanfocuscountriesfortheAU/NEPAD-commissionedAfricaInfrastructureCountryDiagnosticproject,IrvingandManrothfoundthatin12ofthecountrieswithapensionsysteminplace,DCschemeswerebecomingmoreprevalentwhiletheroleofDBschemeswasdecliningaspensionsystemsoverallallowedalargerroleforprivatelymanagedpensionfundadministrators.SeeIrving,JacquelineandAstridManroth,“LocalSourcesofFinancingforInfrastructureinAfrica,”PolicyResearchWorkingPaper(2009).13See,e.g.,presentationin2012byMushi,Ansgar,directorofresearchandpolicydevelopment,SSRA-Tanzania,“PensionDevelopmentsinEastAfrica.”14SeeStewart,Fiona,“ProvingIncentivesforLong-TermInvestmentbyPensionFunds:TheUseofOutcome-BasedBenchmarks”(2014),WorldBankPolicyResearchWorkingPaper6885(Washington:WorldBank).15NzomoMutuku,KoomeKathurima,andCheropToroitich,“ViabilityofaMultiManagerApproachtoInvestmentofRetirementBenefitsAssetsinKenya,”RetirementBenefitsAuthorityofKenya(May2013).

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AsrequiredbytheRetirementBenefitsAct,theseclientsprovidethefundmanagerswithabroadinvestmentpolicythatmay,forexample,includecapsonassetallocationbutalsoallowsthemanagersflexibilitytomakecriticalinvestmentdecisions.Ofthefirmssurveyedforthisstudy,morethanhalfhiredexternalfirmstomanagesomeoralloftheirassets.(SeeBox2below.)

Insurancecoverage

Insurancecoveragealsoremainslowintheregion,reflectinglowincomesandweakcontractenforcement.16Inmanycountries,theinsurancesectorsarefragmentedanddominatedbygeneralinsurancefirms.AccordingtoBeck,Maimbo,Faye,andTriki(2011),demandforlifeinsuranceacrossAfricaremainslimitedbylackofaffordability,lackofawareness,lowtrust,andinadequateconsumerprotection.Theinsurancesectorcontinuestofacechallengesofbuildingtrust,controllingcosts,andensuringthatconsumerfinancialeducationandprotectionkeeppacewithproductinnovation.Atthesametime,thedemandforinsuranceproductsisgrowing,particularlyasyoungandgrowingmiddle-classpopulationsexpand.Technology-enabledsolutionssuchasmobilemoneyarehelpingtodrivethesector’sgrowth,enablinginsurerstoreachnewcustomers—todeliveraswellaspromotetheseproducts.

Deepeningassetpools

Overall,theinstitutionalinvestorbaseisexpandingintheEACfocuscountries.National-levelstatisticsshowthattotalAUMforpensionfundsandinsurancecompanieshavenearlydoubledinrecentyears,from$10.7billionin2011toabout$19.1billionin2015.17AsshowninFigure1,theAUMoffirmsthatparticipatedinthisstudy,asestimatedinU.S.dollars,hasgrownfrom$3.9billiontojustunder$10billionovertheperiod.ThecombinedAUMforinstitutionalinvestorsinoursurveysamplerepresentsabout49percentoftotalassetsmanagedbypensionfundsandinsurancefirmsintheEAC.

16Forcomparison,directgrossinsurancepremiumsinOECDcountrieswere9percentofGDPin2011.See“InsuranceandPensions:KeyTables”fromOECD(2013),Table4.17Nationalregulatorandauthorcalculations.

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5

10

15

20

25

Year-end2011 Year-end2012 Year-end2013 Year-end2014 Year-end2015 June2016

US$billions

TotalsampleAUM Totalpensionandinsurancesectors'AUM

Sources:MilkenInstituteCenterforFinancialMarketsestimatesbasedondataprovidedbynationalpensionindustryandinsurance-sectorregulators;MilkenInstituteCFMsurveyofEACinstitutionalinvestors

FIGURE 1. Assets under management by pension funds and insurance f irms have been increasing

AUMfortotalsurveysampleandtotalpensionandinsurancesectorsintheEACfocuscountries Note:ThetotalAUMfigurefortheEACfocuscountries’pensionandinsurancesectorsforyear-end2015includesprojectedAUMfiguresfortheinsurancesectorinUgandaandmidyearAUMfiguresfortheRwandanandTanzanianpensionsectors.

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BOX 1. Savings rates in EAC countries Nationalsavingsratesinfluencetheamountofmoneythatcanbechanneledintothepensionandassetmanagementsectors,which,inturn,determinestheamountofmoneythesesectorshavetoinvest.Theaveragegrosssavingsrateacrosssub-SaharanAfricawas13.8percentin2015—substantiallylowerthantheaverageof31percentforalllow-andmiddle-incomecountriesworldwide.18Lowandunstableincomelevels,aswellstill-highilliteracyratesandlowlifeexpectancies,continuetokeepsavingsratesrelativelylow.19Inanalyzingitsowncountry’slowsavingsrate,Rwanda’sMinistryofFinanceandEconomicPlanningidentifiedadditionalfactors,suchaslackofasavingscultureandlimitedaccesstoformalbankingservices,particularlyinruralareas.20

Recognizingtheneedtoboostregionalsavings,in2011theEAC’sFourthDevelopmentStrategyidentifiedasavingsratebenchmarkofatleast20percentofGDP,callingonthememberstatestocultivatea“savingsculture”withintheirpopulations.21ActualprogressamongtheEACfocuscountriesinraisingsavingsrateshasbeenmixed.ThegrosssavingsratesforRwandaandUgandain2015were14.1percentand16.7percent,respectively—roughlycomparabletotheaverageforsub-SaharanAfricaasawhole.However,Kenya’sgrosssavingratewasquiteabitlower,at10.7percent,whileTanzania’swassignificantlyhigher,at22.5percent.22

HighersavingsratesinTanzaniacanbeattributedtodeceleratinginflationandtheconsequentriseinrealinterestrates,aswellasGDPgrowthgainsandincreasesintheworking-agepopulation.23Kenya’ssavingsratehasfallenbyathirdinthedecadesince2006,whichtheWorldBankattributestoacombinationoffactorsincludinghighyouthunemployment,risingpricevolatilitycausinglow-to-negativerealratesonbankdeposits,increasesinhouseholdborrowingasincomeshaverisenandfinancialaccesshasimproved,andhighbudgetdeficits.24

Lookingahead,policymakerscanhelpspuranincreaseintheirnationalsavingsratesbytakingstepstocreatemorejobopportunitiesforyouth;reduceandcontaininflationrates,whichshouldencouragehouseholdsandcompaniestosaveandinvestmore;andshiftpublicspendingawayfromgoodsandservicesandmoretowardinfrastructureandotherinvestmentsthatraisetheeconomy’sproductivecapacity.

IV.DriversofassetallocationbyinstitutionalinvestorsInthissection,welookathowinstitutionalinvestorsintheEACmanagetheirportfoliosinresponsetotheregulatory,capacity,andotherdriversthataffecttheirabilitytodiversifyacrosslocalassetclasses.First,welookatthedifferentapproachestakenbythenationalregulators—includingwhetherandto 18GrosssavingsasapercentofGDP.SeeWorldBank,WorldDevelopmentIndicators,GrossSavings(%ofGDP),accessedJan.9,2017.19See,e.g.,Beck,Maimbo,Faye,andTriki,“FinancingAfrica:ThroughtheCrisisandBeyond”(2011),p.61.20RwandaMinistryofFinanceandEconomicPlanning,“RwandaFinancialSectorStrategy:2013-2018”(2013),p.iii.21EastAfricanCommunity,“FourthEACDevelopmentStrategy(2011/12–2015/16)”(2011),p.17.22WorldBank,WorldDevelopmentIndicators,GrossSavings(%ofGDP),accessedJan.9,2017.LatestdataforKenyais2014.23 RealinterestratesinTanzaniaincreasedfrom-5percentinlate2011to7percentinmid-2013.SeeWorldBank,“TanzaniaEconomicUpdate:RaisingtheGame—CanTanzaniaEradicateExtremePoverty?”(2013),p.8.SeealsoWorldBank,“Kenya–CountryEconomicMemorandum:FromEconomicGrowthtoJobsandSharedProsperity”(2016),p.61.24 WorldBank,“Kenya–CountryEconomicMemorandum:FromEconomicGrowthtoJobsandSharedProsperity”(2016),p.59.

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whatextenttheyimposequantitativelimitsonpensionfunds’andinsurers’portfolioallocationbyassetclass.Next,weconsiderwhereinstitutionalinvestorsactuallyallocateassetslocallyinthesecountries—andhowthisstacksupagainsttheirowninternaltargets,aswellastheregulatoryrestrictions.Finally,weturntothequestionofhowtheseinvestorsviewtheirowninformationtechnology(IT)andhumancapabilitiesforexecutinginvestmentstrategy,aswellastheirself-reportedcapacityforassessingdifferenttypesofrisk.

A.Nationalregulatoryconstraints

AscapitalmarketsacrosstheEACdevelopandtherangeofinvestablesecuritiesincreases,nationalregulatoryapproacheshavebeenevolvingtokeeppace.Policymakerssharethebroadaimofstrikingtherightbalanceinimplementingrulesandguidelinesthatdeepenthelocalinstitutionalinvestorbasewhilesafeguardingthepublic’ssavings.Inthepast,pensionandinsurancesectorsinmanyAfricancountrieswereeitherunregulatedoroperatedunderincomplete,highlyrestrictive,orfragmentedregulations.25Inrecentdecades,however,manycountries,includinginEastAfrica,haveestablishedclearregulatoryframeworksanddedicatedregulatorybodies.WithintheEAC,Kenyatooktheleadonpension-sectorreformwiththepassageoftheRetirementBenefitsActof1997,followedbytheestablishmentin2000oftheRetirementBenefitsAuthorityandacomprehensiveregulatoryframework.TheotherEACcountrieshavereformedtheirpensionsectorsmorerecently.Regulationsgoverningtheinsurancesectordatebacktothe1980sand1990sandalsocontinuetoevolve.

Regulationsregardingassetallocationmayhavebeensetwithatleastapartialviewtothecurrentlylimitedavailableinvestmentoptionsincertainmarketsandassetclasses.Regulatoryapproachesaswellasinvestorresponsesmayalsoreflectalackoffamiliaritywithnewerassetclasses.Inthecaseofprivateequity(PE)andventurecapital(VC),inparticular,regulatoryapproachesarestillevolvingandunclear.Preferentialtreatmentgenerallygiventogovernmentsecuritiesthroughregulatoryapproaches—specifically,relativelyhighportfolioceilings—mayinducepensionfundstooverallocatetothisassetclassattheexpenseofothers.26Atthesametime,theinvestmentceilingsforrealestatemayalsobeconsideredrelativelyhigh.

Aspensionandinsurancesectorscontinuetoevolve,furtherreformscanbeexpectedintheyearsahead.Forexample,theKenyanNationalTreasuryhasproposedmergingtheRBA,theInsuranceRegulatoryAuthority(IRA),andotherfinancial-sectorregulatorybodiesintoasingleFinancialServicesAuthority(FSA).27Inthecomingyears,someEACcountrieswilltransitiontoarisk-basedcapitalregime,whichassignsdifferentcapitalchargestodifferentassetclasses,forregulatinginsurancecompanies.Kenyaisalreadyintheprocessofdoingso,withaviewtowardcompletingthetransitionby2018.28This 25Beck,Maimbo,Faye,andTriki,“FinancingAfrica:ThroughtheCrisisandBeyond”(2011),p.156.26See,e.g.,Roldos,“PensionReform,InvestmentRestrictions,andCapitalMarkets,”IMFWorkingPaper04/4(Washington,DC:IMF).Thiscouldpotentiallycreateacaptivemarketforgovernmentdebtaswellaslimitthedevelopmentofothersecuritiesmarkets.27Ngigi,“TopJobsontheLineasFinancialServicesRegulatorsAreMerged,”BusinessDaily(May31,2016).28“NewRegulatoryFrameworkBringingKenyainLinewithInternationalBestPractices,”OxfordBusinessGroup.Tanzaniahasalsocommittedtoadoptingtheregimeby2020,althoughithasnotyetfinalizedanewregulatoryframework.SeeEY,“Sub-SaharanAfrica:TheEvolutionofInsuranceRegulation”(2016).

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transitionmayaffecthowinsurancecompaniesinvest:Inthecaseofundercapitalizedinsurers,itmayforcethemtodivestatleastaportionoftheirriskierassets.29

NATIONALCEILINGSBYASSETCLASS

Kenya,Tanzania,andUgandaeachmaintainquantitativeinvestmentrestrictionsthatestablishhowmuchpensionfundscaninvestinvariousassetclasses.Rwanda’spensionfundregulationsdonotestablishquantitativeinvestmentrestrictionsforanyassetclass.However,theRSSBdoesmaintaininternalasset-allocationguidelines.SincetheRSSBcontrolsthevastmajorityofassetsinRwanda’spensionsector,thissectionwillpresenttheRSSB’sguidelinesasrepresentativeofthelimitsonRwandanpensioninvestments.30Asforassetmanagementcompanies,Ugandanregulationsdonotexplicitlyaddressportfolioallocationlimits.InKenya,however,assetmanagersfacethesamerestrictionsaspensionfundswhenactingaspensionfunds’agents.31

NationalregulationsinKenya,Tanzania,andUgandasetcomparativelyhighceilingsonthemaximumshareoftheportfoliothatpensionfundscanallocatetolocalgovernmentsecurities.(SeeTable2.)InRwanda,theRSSBsetsceilingsof5percentforgovernmentbillsand50percentforgovernmentbonds.32Tanzaniaalsorequiresthatpensionfundsinvestaminimumof20percentoftheirportfoliosindomesticgovernmentsecurities.33TheOECD’s“GuidelinesonPensionFundAssetManagement”recommendsthatregulatorssetminimumrequirementsonlyinexceptionalcircumstances.Thereasoningisthatinvestmentminimumsforceinstitutionalinvestorstoallocatefundstoassetclassestheymightconsider“unwiseinvestmentsorinvestmentsinappropriatefortheirportfolios,”andmayhavetheeffectofinflatingpricesoftheassetsinquestion.34

Thecountriesgenerallysettighterlimitsonpensionfundinvestmentindemandversustermdeposits.Ceilingsonpensionfundinvestmentinrealestatearesimilartothosesetfortermdeposits.

29Genga,“ShakeoutLoomsforKenyanInsurersSqueezedbyCapitalRules,”Bloomberg(July14,2016).30Itshouldbenoted,however,thattheselimitsaresubjecttoregularrevisionbytheRSSBanddonotcarrythesameforceasregulatoryrestrictions.31KPMG,“AfricaFundsandFundManagementIndustry”(2013),p.28.32Theseguidelinesincludestrategicpolicyweightsaswellastacticalminimumandmaximumpolicyweights.AsdefinedintheRSSB’sIPS,thestrategicpolicyweightsrepresentthe“optimumasset-allocationtargets.”Thetacticalminimumsandmaximums“representtherangewithinwhichtheallocationsareallowed.”Formore,seeRwandaSocialSecurityBoard,“InvestmentPolicyStatementforPensionandOccupationalHazardSchemes”(2016).33BankofTanzania,“TheSocialSecuritySchemesInvestmentGuidelines”(2015).Inaddition,Tanzaniarequiresthatifpensionfundsaretoinvestinsecuritiesotherthangovernmentbillsandbonds,thesesecuritiesmusthavehigherex-antematurity-adjustedreturnsthangovernmentbillsandbonds.Iftheydonot,pensionfundsmustsecurepermissionfromtheBankofTanzaniapriortoinvesting.34OECD,“OECDGuidelinesonPensionFundAssetManagement”(2006),p.12.

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TABLE 2. Investment l imits for pension funds in government debt, bank deposits, and real estate

Maximumallowed(%oftotalAUM)–Pensionfunds

Government* BankdepositsRealestate

Bills Bonds Demand TermKenya 90% 5% 30% 30%+30%**

Tanzania 70% - 35% 30%Uganda 80% 5% 30% 30%

Rwanda(RSSB) 5% 50% 5% 40% 35%*RegulatorylimitsforgovernmentdebtinKenya,Tanzania,andUgandaapplytocombinedtotalsofgovernmentbillsandbonds.**RegulatorylimitforKenyanpensionfundsis30%forimmovablepropertyand,separately,30%forREITs.Sources:RegulatoryauthoritiesinKenya,Tanzania,Uganda,andRwandaandtheRSSB

Forcorporatebonds,pensionfundsinthefourfocuscountriesaresubjecttoinvestmentlimitsthatfallwithinarangeof20percentto30percent.(SeeTable3.)KenyanandUgandanpensionfundsmayinvestupto70percentoftheirassetsinequitieslistedonastockexchange,whileinTanzaniatheceilingisamuchlower20percent.InRwanda,theRSSBappliesacombinedmaximumof40percentforpublicandprivateequity.ThethresholdforPEandVCinKenyaandUgandaissetat10percentand15percent,respectively,whileTanzania’sregulatorshavenotyetspecificallyrecognizedthisassetcategory.

TABLE 3. Investment l imits for pension funds in corporate bonds and equities

Maximumallowed(%oftotalAUM)–Pensionfunds

Corporatebonds* Publicequities Privateequity/venturecapitalKenya 20% 70% 10%

Tanzania 20% 20% -Uganda 30% 70% 15%

Rwanda(RSSB) 20% 40%*Regulatorylimitsforcorporatefixed-incomesecuritiesacrosstheEACgenerallyapplytocombinedtotalsofshort-termcommercialpaperandcorporatebonds.AnexceptiontothisisKenya,whichreviseditspensionfundinvestmentguidelinesin2016tosplitcorporatebonds/mortgagebondsandcommercialpaper/unlistedbondsintoseparatecategories,withinvestmentlimitsof20%and10%,respectively.Sources:RegulatoryauthoritiesinKenya,Tanzania,Uganda,andRwandaandtheRSSBAtthesametime,theinvestmentceilingsforrealestate,whichallowpensionfundsacrossthefourcountriestoallocateaboutone-thirdofportfolioassets,maybeconsideredrelativelyhigh—especiallygiventheilliquidnatureoftheseassets.Institutionalinvestorsmayfinditeasiertoassignavaluetorealestate,whichistangible,comparedwithcorporatebonds,equities,andothersecurities.35Anotherreasonmaybethatasinvestmentmanagersseektodiversifybeyondgovernmentdebtandbankdeposits,theyencounteradearthofotherinvestableproducts.36Thehighinvestmentlimitsforreal

35HonahanandBeck,“MakingFinanceWorkforAfrica”(2007).36WorldBank,IMF,andOECD,“CapitalMarketsInstrumentstoMobilizeInstitutionalInvestorstoInfrastructureandSMEFinancinginEmergingMarketEconomies”(2015).

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estatemayreflectbothadesireonthepartofthegovernmenttoaccommodatethisreality,byacknowledgingthatinvestorslackotheroptions,aswellasadesiretoreinforcethisrealitysoastochannelinvestorfundsintotherealestatesector.

Takenasawhole,theEACrestrictionsonpensionassetallocationsarenotatypicalofregulationsgoverningpensionfundsindevelopingcountries,wherequantitativeinvestmentlimitsdominateoverqualitativeregulationssuchastheprudent-personrule.However,thiskindofregime,asChan-Lau(2004)andothersargue,mayforceinstitutionalinvestorstoallocatefundstoassetclassestheyotherwisewouldnothaveselectedandmayimpedeoptimalportfoliodiversification.Therigidityofinvestmentminimumscanalsoimpedeinvestors’roomtomaneuverinthefaceofchangingfinancialmarketsorconditions.37

RegulatorsinthefourEACfocuscountriesallimposequantitativeinvestmentrestrictionsontheassetclassesthatinsurancefirmscaninvestin.38Ugandahasformulateditsrestrictionssomewhatdifferentlyfromtheothercountries,however,andtheseguidelinesaredealtwithseparatelybelow.

Tables4and5showtheregulatorylimitsforlifeinsurancefirms.39InKenya,Tanzania,andRwanda,itwouldbepossibleforthesefirmstoinvesttheirentireportfoliosingovernmentdebt.Allthreecountriesalsosetveryhighceilingsoninsurers’investmentsintimedeposits.Kenyaninsurancefirmsmayallocatealargemajorityoftheirportfoliostorealestate,incontrasttoinsurersinTanzaniaandUganda.

37Chan-Lau,“PensionFundsandEmergingMarkets,”IMFWorkingPaper04/181(Washington,DC:IMF).38Kenyaisintheprocessoftransitioningfromoneregulatoryregimetoanotherinregulatinghowinsurersallocateassets.Thepreviouslawwasrepealedin2015,andtheimplementingrulesforthenewlawarestillunderconsideration.ForKenya,thissectionwillconsiderthedraftinvestmentguidelinespublishedin2015,withthecaveatthattheyhavenotbeenfullyimplementedandmaybefurtherrevised.39Itshouldbenotedthatnotallinsurancefirmssharethesameriskprofile.Non-lifeinsurers,whichprovideautoinsuranceandhomeinsurance,amongotherproducts,haveshorter-termliabilitystructuresthanlifeinsurersdo.Toensuretheyhavesufficientliquiditytocoverpolicyholders’claims,non-lifeinsurersmustkeepalargershareoftheirassetsinmoreliquidinvestmentvehicles.Lifeinsurers,whichhavelonger-termliabilitystructures,havegreatercapacity—andneed—toinvestinlonger-termassets.InvestmentregulatoryframeworksinTanzaniaandUgandabothrecognizethisdistinctionbypermittinglifeinsurerstoinvestmoreoftheirportfoliosinpublicequities,corporatebonds,andrealestate.TheinvestmentregulationsofKenyaandRwanda,however,donotsetdifferentlimitsfornon-lifeandlifeinsurers.

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TABLE 4. Investment l imits for insurance f irms in government debt, bank deposits, and real estate

Maximumallowed(%oftotalAUM)–Lifeinsurancecompanies

Government* Bankdeposits

Realestate**Bills Bonds Demand Term

Kenya 100% 30% 95% 70%Tanzania*** 100% 100% 30%Rwanda**** 100% 30%

*RegulatorylimitsforgovernmentdebtinKenyaandTanzaniaapplytocombinedtotalsofgovernmentbillsandbonds.**Asdrafted,theKenyanregulatoryregimewillallowinsurerstoallocateupto70%toinvestmentproperties,upto50%ofAUMtolandandbuildings,andupto10%toREITs.Tanzanianlifeinsurancecompaniesmayalsoplaceupto50%ofassetsinresidentialmortgages.***ForTanzanianlifeinsurancefirms,atleast40%ofportfolioassetsmustbeinvested,inonewayoranother,intheseassetclasses:governmentsecurities,BankofTanzaniasecurities,prescribedstatutorybodies’securities,localauthorities’securities,and-orbankdeposits.****TheRwandanregulatoryregimeallowsinsurerstoinvestupto100%ofassetsintoanymixofgovernmentsecuritiesandbankdeposits.Sources:RegulatoryauthoritiesinKenya,Tanzania,andRwandaTable5summarizesthecapsonlifeinsurancefirms’investmentincorporatebonds,equities,andPE/VC.Tanzaniaallowsforarelativelyhigherpercentageofassetstobeinvestedincorporatebonds.Allthreecountries’regulatorsimposeasimilarcaponinvestmentinpublicequities.Noneofthecountries’regulationsreferspecificallytoprivateequity.

TABLE 5. Investment l imits for l i fe insurance f irms in corporate bonds and equities

Maximumallowed(%oftotalAUM)–Lifeinsurancecompanies

Corporatebonds* Publicequities Privateequity/venturecapital

Kenya 10% 30%ordinaryshares+10%preferredshares

-

Tanzania 50% 30% -Rwanda 20% 30% -

*Regulatorylimitsforcorporatefixed-incomesecuritiesinTanzaniaandRwandaapplytocombinedtotalsofshort-termcommercialpaperandcorporatebonds.Kenya’sdraftguidelinesdistinguishbetweencorporatebonds,corporatepaper,andothercorporatedebtsecurities.Sources:RegulatoryauthoritiesinKenya,Tanzania,andRwandaUganda’sregulatoryapproachtoinsurers’portfolioassetallocationdiffersfromthoseofthethreeotherfocuscountries.Ugandangeneralandlifeinsurancecompaniesarerequiredtoinvestaminimumof20percentand30percent,respectively,ingovernmentsecurities.

Onmeetingthisrequirement,theymayinvestnomorethan35percentofassetsinrealestateand“aproportionofnotmorethan35percentinatleasttwo”ofthefollowingassetcategories:Ugandangovernmentsecurities,BankofUgandasecurities,mortgages,debentures,commercialpaper,listed

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equities,investmentsinbuildingsocieties,policyloans,fixeddeposits,promissorynotes,andEastAfricanDevelopmentBankandPreferentialTradeAreaBankbonds.Fornon-lifeinsurers,therequirementsarestructuredinthesameway,butthepercentagesare25percentand25percent,respectively.

B.Driversofassetallocation:Theoryvs.empiricalfindings

Asset-allocationapproachescanvarybytypeofinstitutionalinvestor,basedondifferingliquidityneedsandliabilitystructures.Becausepensionfundsgenerallytendtohavealonger-termliabilitystructure,theyhaverelativelylimitedshort-termliquidityneedsasidefromhavingtomakeregularpaymentstotheircurrentbeneficiaries.Tomeettheirwithdrawalneeds,non-lifeinsurers,whoseproductsincludeautoinsuranceandhomeinsurance,haveshorter-termliabilitystructuresthandolifeinsurers.Toensuretheyhavesufficientliquiditytocoverpolicyholders’claimsandavoidanasset-liabilitymismatch,non-lifeinsurerstendtokeepalargershareoftheirassetsinmoreliquidinvestmentvehicles.Lifeinsurers,whichhavelonger-termliabilitystructures,havegreaterneedtoinvestinlonger-termassets.Reinsurancefirmstendtoholdsizableshort-term,liquidassetssotheycanmakeassetsavailabletoinsurancefirmsthatexperiencelargelosses.

Fromarisk-returnstandpoint,itdoesnotmakesenseforaninvestor,particularlyonewithlong-termliabilities,toholdasignificantshareofassetsinlow-yieldingdemandorshort-termtimedeposits.Heavyholdingsinshort-termgovernmentsecuritiesalsotypicallyarenotoptimalfromthestandpointofgeneratingreturns.40Thiscouldpotentiallycreateacaptivemarketforgovernmentdebtaswellaslimitdevelopmentofothersecuritiesmarkets.41Morediversifiedportfolioholdingsacrossassetclasseswherereturnsarenothighlycorrelatedcanprovideawaytomanagerisk,aswellasgeneratereturns.42

However,facedwithalackofalternativeinvestmentinstruments,itisnotuncommonforinvestorsdomiciledinbank-dominatedfinancialsystemstoholdmostoftheirassetsinrelativelylower-yieldingassetssuchasbankdepositsandshort-termgovernmentsecurities.Equityandcorporatebondmarketsinunderdevelopedfinancialmarketsworldwidefacethechallengeofattractingmorelocalfirmstolist—soastoincrease“investableproduct”andimprovethecapitalmarket’soveralleffectivenessinintermediatingfinance.Evenwherepensionfundsinvestin(orsell)thesesecuritieslistedonsmall,illiquidequitymarkets,theshortageofretailandotherinvestorsmeanstheycanenduphavingverylargeeffectsonmarketshareprices.Investorconcernsaboutilliquidityandtheirabilitytoexit,aswellasuncertaintyabouthowrestrictionsapply,alsotendtoimpedetheirdiversificationintotheseassetclasses.

AndtheverysmallsizeofPE/VCmarketsgenerallyinunderdevelopedfinancialmarketsmeansinvestorscanalsofinditdifficulttoexitthesemarketsandgetotherinvestorstotakeupstakes.Atthesametime,recentstudieshavefoundthatAfricaninstitutionalinvestors’demandforthisassetclasshasbeen

40Ashiagbor,Davidetal.,“PensionFundsandPrivateEquity:UnlockingAfrica’sPotential”(2014),(London:CommonwealthSecretariat).41Roldos,“PensionReform,InvestmentRestrictions,andCapitalMarkets,”IMFWorkingPaper04/4(Washington,DC:IMF).42See,e.g.,theseminalarticlesbyMarkowitz,Harry,“PortfolioSelection”(1952),JournalofFinance7,pp.77-91andRoy,A.D.,“SafetyFirstandtheHoldingofAssets”(1952),Econometrica,Vol.20,pp.431-49.

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growing.43Thisformoflonger-termprivatecapitalcanprovideacriticalsourceoffinancetohigh-growthpotentialstartupsandotherfirmsoperatinginstrategicallyimportantsectors,whichcandiversifyeconomiesandhelpcreatejobs.

Changesinthemacroeconomiccontext—particularlywithrespecttoinflationandnominalinterestrates—mayaffectthevalueandvolatilityofinstitutionalinvestors’balancesheetsonboththeassetandliabilitysides.This,inturn,caninfluencehowtheseinvestorsallocateportfolioassets.Astablemacroeconomiccontextisaprerequisitetothefunctioningofinstitutionalinvestorsandcapitalmarketsbroadly.

Tangibleassetscanbeparticularlyattractiveinfinancialsystemswheremostavailableinvestmentvehiclesgeneraterelativelylowreturns,especiallyinrealterms.Inmanyunderdevelopedfinancialmarketswherebankspredominateandarangeofinvestablesecuritiesislacking,localinstitutionalinvestorsmaytendtorelymoreheavilythanotherwiseonrealassetssuchasrealestate.However,realassetsbearotherportfoliorisks,suchaspricevolatilityandilliquidity.Wheninvestorsturntoinvestingsizableamountsintangibleassets—buyinguprealestateandproperty—thisactivitycandriveuppricesinthosemarkets,especiallyinurbanareas.Thiscanhaveworryingbubbleconsequences,however.Thefactthatrealestatemarketscanbesubjecttosuddenpriceswingsandlargechangesinvalueovertimecancausetheshareofassetsinvestedinrealestatetoalsoundergosuddenandlargeshifts.

Howinterestratechangesaffectinstitutionalinvestorsdependsonthenatureanddegreeofthematuritymismatchontheirbalancesheets.Forpensionfundsandlifeinsurancefirms,itisdifficulttoneutralizeinterestrateriskcompletely,asthedurationoftheirliabilitiesusuallyexceedsthedurationoftheirassets.Thisisparticularlytrueforpensionfundsandlifeinsurancecompaniesindevelopingcountries,duetothelowavailabilityoflong-datedsecurities.Interestratedeclinescanbeparticularlydifficulttomanage.Owingtomaturitymismatches,theyusuallyraisethepresentvalueofliabilitiesmorethantheyraisethepricesofportfolioassets,wideningthefundinggap.Forpensionfundsandinsurancecompaniessubjecttoanasset-liability-matchingframework,closingthefundinggapnecessitateseitheranincreaseinpremiums(forinsurancecompanies)orcontributions(forpensionfunds).Otherwise,institutionsmayshifttoriskierassetsinthehopeofsecuringhigherreturns.44

Asdescribedbysurveyrespondents,theasset-allocationpracticesofEACinstitutionalinvestorsbroadlyconformtowhattheoryandbestpracticeswouldsuggest,albeitwithsomeexceptionsandsubjecttotheconstraintsoftheirmarkets.Asmightbeexpected,giventheirdifferentliquidityneeds,thepensionfundssurveyedtendtoholdsmallercashpositionsthantheinsurancefirms.Inaddition,althoughinvestors’allocationstogovernmentsecuritiesmaybeconsideredhigh,theyhave,atleastinsomecases,declinedinrecentyears,asabroaderrangeofinvestmentproductsbecomesavailable.Moreover,pensionfundstilttheirinvestmentsingovernmentsecuritiestowardissuanceswithlongermaturities,andalsoinvestameaningfulportionoftheirportfoliosinequities,bothofwhichservetoextendthematurityprofileoftheirassets.Investmentsincorporatebondsremainlow,likelyowingto 43SeealsoFSDAfricaandEMPEA,“ConduitsofCapital:OnshoreFinancialCentersandtheirRelevanceforAfricanprivateEquity”(2015)(Nairobi:FSDAfrica).44CommitteeontheGlobalFinancialSystem,“FixedIncomeStrategiesofInsuranceCompaniesandPensionFunds”(2011),CGFSPapersNo.44.

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thenascentstatusofthesemarketsinallbutKenya.Realestatestillmakesupasignificantproportionofmanyinvestors’portfolios.

PENSIONFUNDSHAVEDIVERSIFIEDAWAYFROMCASHANDDEPOSITS

ThereareclearsignsthatpensionfundsintheEAChavebeentakingamorediversifiedportfolioapproachoverthepastdecade,shiftingfurtherawayfromthemostliquidassetclassesofdemanddepositsandcash.Surveyedpensionfundsholdarelativelysmallshareoftheirportfoliosinhighlyliquiddemanddepositsandcash,withtheaverageacrosscountries1percent.Asmanyas10pensionfundsholdnone,andtheupperendoftherangeforholdings(byjustonefirm)is5percent.Thisupperrangeof5percentgenerallyisinlinewiththelowceilingsetbynationalregulatorsforpensionfundholdingsindemanddeposits.(Seealsoabove.)

Findingsfromoursurveyedsampleofpensionfundsalsoreflecttheindustrywidetrendsforpensionfundsinthefocuscountries.Accordingtoaggregatedatacollectedbynationalregulatorsandothersources,theproportionthatpensionfundsindustrywideinKenyaholdincashanddeposits(demandplustime)fellfrom3percentoftotalportfolioassetsin2006to1.4percentatyear-end2015.PensionfundsindustrywideinUgandaheldclosetonoassetsincashanddeposits,downconsiderablyfrom26percentin2006.InTanzania,thepensionsectorheldanestimated9percentincashanddepositsatyear-end2015,downslightlyfrom11percentadecadeearlier.

Insurersgenerallyholdalargerportfolioshareincashanddepositsthanpensionfundsdo.Asaresult,holdingsinthismostliquidassetclassvarywidelyacrossalltypesofsurveyedinstitutionalinvestors,fromalowof1percenttoahighof80percent.Insurers’largerholdingsincashanddepositsmaybeencouragedbyregulators’generallyhighceilingsontheshareofaninsurer’sportfoliothatcanbekeptinbankdeposits.45

Butwithonlyonesurveyedfirm,areinsurancefirm,holdingasmuchas80percentinthisliquidassetcategory,thismakesthemedianvalueof3percentmoremeaningful.46Asidefromthisfirm,thelargestholdingamongsurveyedinsurersisbyanon-lifeinsurer(40percent).Aswouldbeexpected,non-lifeinsurersandreinsurers,whichtypicallyhaveshorter-termliabilitystructuresthanlifeinsurersandpensionfunds,haveportfoliosthatgenerallyaremoreheavilyweightedinthisassetcategory.Surveyednon-lifeinsurersandreinsurershaveaverageportfolioholdingsof19percentincashanddemanddeposits,withamedianfigureof10percent.

HOLDINGSINSHORT-TERMGOVERNMENTSECURITIESFALLBELOWNATIONALANDEVENINTERNALCEILINGS

Twelvepercentofallsurveyedinstitutionalinvestorsholdatleastone-thirdoftheirportfolioinshort-termgovernmentsecurities.47Theshareofthesesecuritiesheldbypensionfundsvariesconsiderably

45TheRwandanregulatoryregimeisdifferent,allowinginsurerstoinvestupto100percentofassetsintoanymixofgovernmentsecuritiesandbankdeposits.46Reinsurancefirmstendtoholdsizableshort-term,liquidassetssotheycanmakeliquidassetsavailabletoinsurancefirmsthatexperiencelargelosses.47Debtsecuritiesissuedbythegovernmentwithmaturitiesranginguptooneyear.

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withinandacrossdomicilecountries,however.InKenya,surveyedpensionfundsallocateanaverageof21percentoftheirportfoliostothisassetclass,butactualamountsbyindividualfundvaryconsiderably,from2percentto86percent.Similarly,InUganda,surveyedpensionfundsallocateanaverageof20percenttoshort-termgovernmentsecurities,butactualamountsheldbyindividualfundsvaryfromnoholdingsto45percent.InTanzania,theaverageallocationis3percent,representingactualallocationsrangingfromnoholdingstoahighof6percent.InRwanda,theallocationis3percent.

Actualallocationstoshort-termgovernmentsecuritiesbypensionfunds,onaverage,arewellbelownationalceilings.ThemaximumportfoliosharethatpensionfundsinTanzania,Uganda,andKenyaarepermittedtoinvestintotalgovernmentsecuritiesgenerallyrangesfrom70percentto90percent.(Seeabove.)Itshouldbenotedhere,however,thatpensionregulatorsinthesethreecountriescombineshort-,medium-,andlong-termgovernmentsecuritiesasoneassetclassintermsofsettinglimitsonportfolioholdings.Rwanda’sRSSBhassetasignificantlylowerandseparateceilingof5percentforthesharethatitcaninvestinshort-termgovernmentsecurities.

Theportfoliosharethatinsurersallocatetoshort-termgovernmentsecurities,onaverage,alsofallswellbelownationalregulators’ceilings—especiallyconsideringthatinKenya,Rwanda,andTanzania,theyessentiallyimposenoceilingoninsurersforthisassetclass.Insurers’averageportfolioallocationvarieswidelybycountry,at23.5percent,1.25percent,and30percent,respectively.AndinsurersinUgandaallocate15.2percentonaverage,whichalsofallswellbelowthatcountry’sceiling.(Seeabove.)48Withnon-lifeinsurersgenerallyhavingshorter-termliabilitystructuresthanlifeinsurers,averageportfolioallocationtoshort-termgovernmentsecuritiesissomewhathigherinthecaseoftheformeracrossthecountries(13.1percent)thanforthelatter(9.9percent).

TanzaniaandUgandaalsosetminimuminvestmentrequirementsforinvestors’holdingsinpublic-sectorsecurities—notdistinguishingbymaturityterms.ForTanzanianpensionfunds,aminimumof20percentofassetsmustbeinvestedingovernmentsecurities.ForUgandangeneralandlifeinsurancecompanies,theminimumsare20percentand30percent,respectively.Althoughregulatorsmayjustifytheseinprudentialterms,investmentminimumsareoftenseenasameansofcreatingacaptivemarketforgovernmentdebt.Becausetheseinvestmentminimumrequirementsdonotspecifybymaturityterms,theymaybeencouragingmoreholdingsinshort-termsecuritiesduetotheshortersupplyoflonger-termsecuritiesinthesemarkets.

Notably,however,thevastmajorityofsurveyedfirmsinKenya,Tanzania,andUgandaalsosettheirowninternaltargetthresholdsforinvestmentsinshort-termgovernmentsecurities,andtheinternalceilingstendtobemorerestrictivethanthenationalceilings.AmongsurveyedRwandanfirms,theseinternaltargetsarelesscommon.Theseinternallysetceilingsmaybetemperinganystrongpreferenceforshort-termgovernmentsecuritiesthatotherwisecouldbeencouragedbythenationalregulatorystance.ForoneofthethreesurveyedpensionfundsinKenyathatsetinternaltargetsforshort-termgovernmentsecurities,theinternalceilingmatchesthenationalregulator’sthresholdof90percent.Butactualinvestmentsin2016fellshortofthattargetby29percentagepoints.Excludingthisfirm,theaverage

48Uganda’sregulatoryapproachvis-à-visinsurers’portfolioallocationtogovernmentsecuritiesimposesaminimumrequirementandthensetsaceilingoverabroadlistofassetcategoriesincludingshort-termgovernmentsecurities.

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maximumthresholdsetinternallyforsurveyedKenyaninstitutionalinvestorswas42percent,andactualinvestmentsfellfarshortoftheseinternalceilingsinallbutonefirm’scase.ForUgandaninstitutionalinvestors,internallysetmaximumthresholdsfellfarshortofthenationalceilinginallcases,averaging35percent,andactualinvestmentsfellshortoftheseinternalceilingsinthemajorityoffirms’cases.InTanzania,theaverageceilingsetbysurveyedfirmswas20percent,wellshortofthenationalceiling.

PENSIONFUNDHOLDINGSINGOVERNMENTBONDSARESIZABLEBUTBELOWCEILINGS

Manysurveyparticipantsholdarelativelyhighshareoftheirportfoliosingovernmentbonds.Asmanyas12percentholdatleasthalftheirportfoliointhisassetclass.Pensionfunds,inparticular,typicallyhaveastrongneedtoinvestinlong-termmaturitiesforsustainablecashflowtopaypensions.(Seeabove.)PensionfundsinKenya,Tanzania,andUgandahaveaverageportfolioallocationstogovernmentbondsrangingfrom31percentto43percent.

Thereisconsiderablevariationamongsurveyedinstitutionalinvestorsinhowheavilytheyweighttheirportfoliosingovernmentbonds,however.Some15percentofsurveyedrespondentsholdnoneoftheirportfolioingovernmentbonds.Amongsurveyedinsurers,theportfolioshareallocatedtogovernmentbonds,rangingfromanaverageof6percentto25percentacrossthecountries,isconsiderablylowerthanthecorrespondingrangeforpensionfunds.Thisfindingisnotsurprisinggiventhatnon-lifeinsurers,whichmadeupamajorityofthesurveysample,haveshorter-termliabilitystructuresandtypicallyareinclinedtokeeprelativelymoreassetsinmoreliquidinstruments.

WherefirmsacrosstheEACcountriessetinternalceilingsontheshareofassetsallocatedtogovernmentbonds,theseceilingstendtobewellunderthenationalceilings.Andfirms’actualinvestmentsingovernmentbondstendtofallfarbelowtheirinternalceilings.AmongsurveyedKenyanfirmsthatsetinternaltargets,one-thirdsetaninternalceilingforinvestmentingovernmentbondsashighas90percentto100percentofAUM.Butactualinvestmentsforeachofthesefirmsfallundertheinternaltargetbyatleast42percentagepoints.Excludingthesefirms,theaveragemaximumthresholdsetinternallyforKenyanfirmsis57percent,andactualinvestmentsfallwellshortofthesetargets.

Aggregatesectordatacompiledbyofficialnationalstatisticalsourcesindicatetheoverallshareheldbynationalpensionsectorsingovernmentsecurities(alltenorscombined)hasdeclinedsignificantlyoverthepastdecadeforKenyanfundsandalsodeclinedsomewhatforTanzanianfundsbutincreasedforUgandanfunds.TheproportionthatKenyanpensionfundsasanindustryholdingovernmentsecuritieshasdeclinedsince2006by12percentagepoints(to29.8percent),whiletheproportionheldbyUgandanfundsincreasedby21percentagepoints(to69.3percent).InTanzania,theproportiondecreasedanestimated4percentagepoints,to20percent.Thetrendsofsignificantdeclineoverthepastdecadeinpensionfunds’holdingsingovernmentsecuritiesmaybeexplainedbyKenya’srelativelymoredevelopedcapitalmarketsofferinginvestorsmoreproductchoices—awiderrangeofinvestablesecurities.Basedonoursurveyofasampleofnationalpensionsectors,wecandeducethatpensionfundsoverallhavealargemajorityofholdingsingovernmentsecuritiesthatareinmedium-tolong-termtenors.(SeeFigure2.)

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FIGURE 2. Surveyed pension funds are holding a relatively higher share of assets in government bonds vs. short-term securit ies

Averageportfolioallocationforshort-termvs.long-termgovernmentsecuritiesatyear-end2015

Investors’still-sizabletotalallocationstogovernmentsecuritiesmaypartlyreflectstrongself-reportedlevelsofcapacity.(SeeFigure3.)Participatinginstitutionalinvestorsratedtheircapacityforassessingshort-termgovernmentsecuritiesasstrongestamongassetclasses:95percentofrespondentsratedthiscapacityasgoodtoexcellent.Asimilarlyhighratio(93percent)ofparticipatinginvestorsreport“good”or“excellent”capacitytoassessgovernmentbonds.

Source:MilkenInstituteCenterforFinancialMarketssurveyofEACinstitutionalinvestors

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Source:MilkenInstituteCenterforFinancialMarketssurveyofEACinstitutionalinvestors

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FIGURE 3. Institutional investors’ reported capacity to assess various asset classes

VERYLIMITEDCORPORATEBONDHOLDINGSREFLECTSMALLMARKETSIZE

Justover40percentoftotalsurveyedinvestorsreportholdingsomeproportionoftotalassetsincorporatebonds,withamountsrangingfrom1percentto14percentoftotalAUM.Butasmanyas57percentofparticipatingsurveyedpensionfundsacrosstheEACcountriesholdnoassetsincorporatebonds.EveninKenya,surveyedpensionfundsreportedholdinganaverageofjust2.5percentincorporatebonds,rangingfromniltoahighof10percent.AggregateindustrydatacollectedfromnationalregulatorsshowtheshareofassetsthatpensionfundssectorwideinKenyaandUgandaholdincorporatebondsincreasedslightlyoverthepastdecade,from4percentto6percentandfrom1.8percentto2.5percent,respectively.49InTanzania,however,dataestimatesshowthatthissharefellforthepensionindustryovertheperiod,from7percentto1percent.

Pensionfunds’limitedprogressindiversifyingintothisassetclassatleastpartlyreflectsalackofproductinthesemarkets.(SeeFigure4.)Thisisnotanuncommonprobleminemergingandfrontiermarketswherethelimitedsupplyofequityandfixed-incomesecuritiesissuedbycorporatesmayimpedeinstitutionalinvestors’desiretofurtherdiversifytheirportfolios.50ListingsofsecuritiesbycompaniesonEACstockexchangesremainsmallinnumberandsize,andamongtheselistings,equityissuespredominate.51InTanzania,therearefewercorporatebondslisted(four)thanevennearlyadecadeago(fivein2007).EveninKenya’smoredevelopedfinancialmarket,therewereonly14firmsthathad

49Fromyear-end2006toyear-end2015.50See,e.g.,Chan-Lau,Jorge,“PensionFundsandEmergingMarkets”(2004),IMFWorkingPaper(Washington:IMF).51See,e.g.,Becketal.,“FinancingAfrica:ThroughtheCrisisandBeyond”(2011).CorporatebondlistingsonEACexchanges,inparticular,haveremainedsmallinnumberandsizeoverthepastfiveyears.

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bondslistedonthestockexchange(comparedwithninein2007)—andthevastmajorityofthesewerefinancialservicesfirms.52

AccordingtoonesurveyedEACpensionfundmanager,thefundhasbeenmanagingitsportfoliopartlywiththeultimateaimofboostingcapital-marketactivityandincreasingavailableproduct.Tothatend,thisfundhasrecentlyincreaseditsallocationofassetsincorporatebonds,fromnearlyzeroto7percentoftheportfolio,whilesimultaneouslyreducingholdingsofbankdeposits,to20percentfrom25percent.Inthisway,thefundexpectsthatitsincreasedholdingsinthisassetclassmayencouragemorefirmstoissuecorporatebonds,deepeningthemarket.

WherepensionfundsinKenya,Tanzania,andUgandasetinternalmaximumtargetsforcorporatebonds,theyweresetatleastseveralpercentagepointsbelowtheirnationalregulators’ceilingsin70percentofsurveyedfunds’cases.For86percentofthefirmsthatsettheseranges,actualinvestmentsfellclosertoorevenbelowthetargetminimum—again,likelydueatleastpartlytolackofproduct.

Aswouldbeexpected,surveyedinsurers’portfoliosinthesecountrieshavelowerholdingsincorporatebondsthanpensionfundsdo.Thislikelyisduetoamixoflimitedproductonthesemarkets,firms’liabilitystructurestendingtofavormoreliquidassets,andtighternationalregulatorylimitsoverallontheirholdings.(Seeabove.)Three-quartersofsurveyedinsurers(allofthesampleinTanzaniaandUganda)holdnoassetsincorporatebonds.EveninKenya,surveyedinsurers’portfolioholdingsaveragejust3.8percent,althoughforlifeinsurerstheaverageisashighas9percent.

FIGURE 4. Corporate bond issues have remained low in number and amount

Numberoflistedcorporatebonds(2007and2016)andtotalamountoutstanding(2016) Sources:Nationalsecuritiesexchangewebsites,Bloomberg

52NairobiSecuritiesExchangewebsite,“BondStatistics,”https://www.nse.co.ke/market-statistics/bonds-statistics.html.

TanzaniaUgandaKenyaRwanda

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Self-ratedcapacityforassessingcorporatebondsasanassetclassisatleastaverageforallparticipatinginvestors.Justoverthree-quartersoftotalparticipantsratecapacityforassessingcorporatebondsasgoodtoexcellent.Thismaybeoverlyoptimistic,however,givenknownfactorssuchascostlyunderwritingprocesses,limitedcredit-riskevaluationcapabilities,andilliquidityimpedingthegrowthofcorporatebondmarketsinunderdevelopedcapitalmarkets.53

PENSIONFUNDSHOLDMUCHMORETHANINSURERSINLISTEDEQUITIES

Nearly60percentofallparticipatingrespondentsholdsomeportionoftheirassetsinlistedequities.Acrossthecountries,however,pensionfundsgenerallyholdalargershareoftheirportfolioinlistedequitiesthaninsurersdo.(SeeFigure5.)InKenya,surveyedpensionfundsholdamountsrangingfrom18percentto28percentoftheirportfoliosinlistedequities,whileinsurers’amountsrangedfromnilto3percent.

Nationalregulatoryceilingsseemrelativelyhigh—ashighas70percentinKenyaandUganda—andsodonotposeadeterrenttopensionfundsseekingtodiversifyintopublicequity.TheproportionthatpensionfundsindustrywideinKenyaholdinlistedequitiesremainedrelativelyconstant:23percentoftotalportfolioassetsversus24percentin2006.PensionfundsindustrywideinUgandahold18percentinlistedequities,upconsiderablyfrom5percentin2006.InTanzania,however,theindustryheldanestimated9percentatyear-end2015,downfrom17percentin2006.

Asmuchasthree-quartersofallsurveyedinsurersacrosstheEACcountriesholdnoneoftheirportfolioinlistedequities.Averageportfolioshareheldbyinsurersinthesecountriesrangedfromniltoahighof9percent.Aparticulardisincentivetonon-lifeinsurersholdingsomeportionoftheirassetsinlistedequitiesistheilliquidityofequitymarketsinthesecountries,whichcanrendertheseinsurersunabletoselloffshareswhenneededandpayclaimsandbenefitstopolicyholders.Nationalregulatoryceilingsoninsurers’holdingsoflistedequitydonotseemtoposeanimpedimenttomoretake-upasactualamounts,evenatthehighestendoftherange,fallfarbelowtheceilings.

Itisnotablethattheoverallshareofpensionfunds’publicequityholdingsbycountryseemstobeinlinewiththesizeofthesecountries’nationalequitymarkets.Mostequitymarketsacrosstheregionfacethechallengeofincreasingproductbyincreasingfundableprojectsandattractingmorefirmstolist.ThechallengeofbringingmorefirmstomarkethasbeenmadesomewhatmoredifficultbydeclinesinstockmarketindicesandreturnsacrossAfricancountriesinthepastyear,asrecord-higheconomicgrowthrateshaveslowedandasinvestorshaveexpectedariseinU.S.policyrates.Evenwherepensionfundstakeup(orsell)sharesoflistedfirmsonsmall,stillilliquidequitymarkets,theshortageofretailandotherinvestorsmeanstheyenduphavingverylargeeffectsonmarketshareprices.

Thelevelofinstitutionalinvestors’confidenceinassessinglistedequitiesishigh.Nearly70percentofsurveyedparticipantsratedtheircapacityasgoodtoexcellent.Infact,onlyoneparticipantratedthiscapacityasbelowaverage.

53Chan-Lau,Jorge,“PensionFundsandEmergingMarkets”(2004),IMFWorkingPaper(Washington:IMF).

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FIGURE 5. Pension funds general ly hold a larger share of assets in l isted equities

ShareofAUMallocatedtolistedequitiesbypensionfundsandinsurersatyear-end2015 Source:MilkenInstituteCenterforFinancialMarketssurveyofEACinstitutionalinvestors

INVESTORSGENERALLYHOLDVERYSMALL,IFANY,AMOUNTSINUNLISTEDEQUITY

Only18percentofsurveyedinstitutionalinvestorsreportholdinganyassetsinventurecapital,privateequity,orotherunlistedequity.Inhalfofthesecases,theamountwasjust1percentofthetotalportfolio.Intheotherhalfofcases,amountsrangedfrom4percentto10percentofassets.Surveyedpensionfundsandassetmanagementfirmshold1percentto5percentoftheirportfolioinPE/VCinKenyaandinsurersholdnone.NosurveyedpensionfundsorinsurersinTanzaniaandnopensionfundsinUgandaholdPE/VCassets.OneparticipatingUgandaninsurerholds1percent.InRwanda,oneinsurerreportedallocatingasmuchas10percentofassetstoprivate/unlistedequity,somewhatunexpectedly.

Evenindevelopedfinancialmarkets,privateequitytypicallyisarelativelysmallportionofpensionfundportfolios.Theaverageprivate-sectorpensionfundinNorthAmerica,forexample,allocated6percentoftotalAUMtoprivateequityinthefirsthalfof2016,accordingtoresearchproviderPreqin.54PrivateequityhasbeenviewedasastronglyperformingassetclassbyinstitutionalinvestorsintheU.S.,wherenetreturnshavebeengreaterthan10percentovera10-yeartimehorizon,comparedwiththeAfricaPrivateEquity&VentureCapitalIndex’s5.2percentreturnrateover10years.55Thatsaid,evenin

54Preqin,“NorthAmerica-BasedPensionFundsinPrivateEquity–May2016,”availableathttps://www.preqin.com/blog/0/14495/north-american-pension-funds.55SeeAfricaVentureCapitalandPrivateEquityAssociation,“KeyFindingsandFAQs:AfricanPE&VCPerformanceBenchmark”(September2016).

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advancedmarkets,alarmbellshavebeenringingmorerecentlyabouttheassociatedrisksandcontinuedabilityofthisassetclasstoreaphighreturns.56

ThereisalsolikelyconsiderableinvestoruncertaintyasEACnationalregulatorsareintheprocessofclarifyinghowtheywilladdressthisrelativelynewassetclass.Asnotedabove,KenyaandUgandahaveonlyrecentlyestablishedspecificregulatorylimitsontheshareofpensionfundportfoliosallocatedtodomesticPEandVC.Intermsofintraregionallimits(discussedingreaterdetailbelow),KenyatreatsPE/VCinvestmentbypensionfundsinotherEACcountriesasforeigninvestments,withstricterlimits,whileinUganda,domesticpensionfundrulesapply.57ForTanzania’spensionfunds,theregulationsonintraregionalPE/VCinvestmentsareasyetunwritten.Noneofthefourcountrieshavespecificallyaddressedinsurancefirms’assetallocationtoPE/VC,evenintheirdomesticmarkets.

Verysmallallocationstoprivateequity,venturecapital,andunlistedequitiesbyinstitutionalinvestorsintheEACpartlyreflectcapacitylimitationsandlackofexperienceinassessingthisassetclass,ratherthanlackofdemand.Only29percentofsurveyedparticipantsreportgoodorexcellentcapacitytoassessthisassetclass,while14percentreportpoororverypoorcapacity.58EvenamongKenyaninstitutionalinvestors,asmanyasthree-quartersreportaveragecapacityatbestinassessingthisassetclass.Institutionalinvestorsmustbeprudentinallocatinginvestmenttoearly-stagefinancingsincefailureratescanbehigh.59AndthesmallsizeofPE/VCandcapitalmarketsgenerallyinunderdevelopedfinancialmarketsmeansinvestorscanfinditdifficulttoexitandgetotherinvestorstotakeupstakes.Itwillbeimportanttoboostcapacityamongregulators,investors,andfinancialintermediariesinevaluatingtherisksaswellastheopportunitiesassociatedwiththisstill-relativelynewsourceofprivatecapital.OnesolutionthatmayaddresscapacityconstraintsandmitigatesomeoftheriskwouldinvolvepoolingandchannelingEACinvestors’moneythroughVC/PEfundsora“fundoffunds”thatcouldbelistedonastockexchange.SuchfundscouldpoolriskbydiversifyinginvestorportfoliosacrossalargenumberofVC-fundedfirmsinthesubregion,forexample.60Asdiscussedbelow,institutionalinvestorshaveexpressedanappetiteforthiskindofproduct.

OVERALLDIVERSIFICATIONAWAYFROMREALESTATE

SurveyedpensionfundsacrosstheEAChold,onaverage,9.3percentofassetsinrealestateandproperty,butassetholdingsrangewidely,fromnilto25percent.AlthoughsurveyedKenyanpensionfundssetinternalceilingsthatareinlinewithnationalregulators’30percentceilingonportfolioallocationtorealestate,theaverageallocationisactually15percent.Similarly,atanaverageof12.4percent,surveyedTanzanianpensionfunds’actualallocationfallsfarshortofinternalceilingsset

56FinancialTimes,“Pensions’ShiftintoPrivateEquityIgnoresRisks”(August26,2016).57Inmanycases,foreign–notintraregional–investmentregulationsapplytoprivateequityinvestments.AllocationstoPEarealsoaffectedbyrestrictionsonforeigninvestmenttotheextentthatthemajorityofAfricanprivateequityvehiclesaredomiciledinMauritius.58Similarly,Ashiagboretal.foundintheir2014studythatamajorreasonAfricanpensionfundswerereluctanttoinvestinprivateequitywasunfamiliaritywiththisassetclass,ratherthananyoutright“aversion”toit.59See,e.g.,thediscussioninVittas(2000)onhowevenasmall,suddenreallocationofpensionassetstowardequitiescouldcauselargeshiftsinmarketpricesinunderdevelopedcapitalmarkets.60Seethisdiscussionin,e.g.,Irving,Schellhase,andWoodsome,“FramingtheIssues:DevelopingCapitalMarketsinRwanda”(2016)(Washington,DC:MilkenInstitute).

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roughlyinlinewithnationalregulators’ceilingsof25percentto30percent.WheresurveyedUgandanpensionfundshaveinternalceilingsonthisassetclass,theytendtobesignificantlybelowthe30percentceilingsetbynationalregulators,averaging10percent.AndactualallocationbyUgandanfundstendstofallwellbeloweventheirinternalceilings,at4percent.

Moreover,aggregatedatacollectedbyregulatorsindicatethatUgandanpensionfundsasanindustryholdsignificantlylessinrealestatecomparedwithadecadeago:2.2percentatyear-end2015,downfrom17percentin2006,whileTanzanianfundscontinuetoholdjustunderone-quarter.Kenyanfunds,however,holdquiteabitmoreinthisassetclass:18.5percentatyear-end2015,upfrom6percentin2006.Thesetrendsmayhaveoccurredatleastpartlyinresponsetotrendsinthecountries’realestatemarkets.Untilearlierthisyear,Kenya’srealestatemarketwaswidelyconsideredtohavebeenabubbleinurbanareas.61Andtherehasbeenstronginvestorinterestinthefirstrealestateinvestmenttrust(REIT)inKenya’smarket,launchedin2015.Regulatorstherehaverecentlysetaseparate30percentceilingonpensionfundportfolioallocationstoREITs.62InTanzania,thepensionfundsectorheldanestimated24percentinrealestateatyear-end2015,comparedwith23percentin2006.Earlierthisyear,TanzanianPresidentJohnMagufulispecificallycalledonthecountry’spensionfundstofurtherdiversifytheirportfoliosawayfromrealestateandinvestmoreinexport-orientedindustrialsectorswithjob-creatingpotential.63

Surveyedlifeinsurersholdanaverageof3percentinrealestateand,somewhatsurprisingly,non-lifeinsurersholdasmuchas10percent,onaverage.Aswithpensionfundholdings,theseaveragefiguresalsomasksignificantvariationbyindividualinvestor.Forexample,AUMinrealestaterangesfromnilto40percentacrossnon-lifeinsurers.

Thereissignificantvariationbycountryofdomicileinhowinvestorsviewtheircapacitytoassessrealestateinvestments.Despiteinvesting,onaverage,about10percentoftheirassetsinrealestate,asmanyas17percentoftotalparticipatinginstitutionalinvestorsratetheircapacitytoassessrealestateinvestmentsaspoor.AllbutoneoftheseisdomiciledinUganda.And40percentoftotalparticipatinginstitutionalinvestorsacrossthecountriesseetheircapacitytoassessrealestateasgoodorexcellent,withahighconcentrationoftheseinKenya.

61TheIndependent,“Uganda:MembersQueryNSSFBosses”(October26,2016).62TheregulatoryceilingsforKenyanpensionfunds’investmentsare30percentforimmovablepropertyand,separately,30percentforREITs.63DailyNews,“NSSF,PPFLinkUptoEstablishSugarFactory”(October22,2016).Mostrecently,NSSFandPPFpooledsomeoftheirassetstoinvestinasugar-processingfactoryinTanzania’sMorogororegion.

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ShareofAUMallocatedtorealestatebypensionfundsandinsurersatyear-end2015Source:MilkenInstituteCenterforFinancialMarketssurveyofEACinstitutionalinvestors

BOX 2. Use of external managers and motivating incentives Institutionalinvestorsfacingfundmanagementcapacityconstraintsoftenlooktoexternalmanagerstoattaintangiblebenefitsfromskilltransfersandtogaina“guidedbenchmark.”InKenya,regulatorsevenrequireprivate,employment-basedprivateschemestoentrustfundstoqualifiedassetmanagers.

NearlyhalfofallsurveyedfirmsintheEACcountriesuseexternalfundmanagers.Amongthesefirms,70percentusesomeformofincentivestomotivatethem.ThetopincentiveusedisvalueandperformanceofAUM(citedbyone-third).Tenpercentsetspecifictargetsandbenchmarksinseekingtomotivateexternalmanagers.

TheuseofexternalfundmanagersislessprevalentinRwandathanintheotherEACfocuscountries,practicedbyfewerthan30percentofsurveyedRwandaninvestors.TheRwandaninvestorsthatuseexternalfundmanagersrelyoncompensationtiedtovalueandperformanceofAUMandtermsspecifiedintheircontractsasmotivatingincentives.Incontrast,only39percentofsurveyedinstitutionalinvestorsintheEACcountriesindicatedtheyusespecificincentivestomotivateinternalfundmanagers.Performance-basedbonuspayisthetopincentiveusedtomotivateinternalfundmanagers,usedbyjustover40percentofthoseresponding.Justoverone-thirdusespecifictargets,benchmarks,andinvestmentpolicyguidelines.InRwanda,useofincentivestomotivateinternalmanagersismuchlessfrequentthanintherestoftheEACfocuscountries:Onlyonesurveyedfirmindicateditusesthese,relyingonperformance-basedbonuspay.

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C.Assessingcapacityforexecutinginvestmentstrategy

Anotherfactorthatinformsafirm’sportfoliostrategyisitsowninternalcapacitytoassessthefinancialinstrumentsavailableandtomaketimelyinvestmentdecisions.TounderstandwhethercapacityissueswereconstrainingtheportfoliodiversificationofEastAfricaninstitutionalinvestors,weaskedaseriesofquestionsabouthowtheyviewtheirinternalresourcesandtheirabilitytoassessseveraltypesofrisk.Wefoundthatinstitutionalinvestorsareoptimisticabouttheirfirms’owninformationtechnology(IT)andhumancapabilitiesforexecutinginvestmentstrategy.Moreover,institutionalinvestorsacrossthefocuscountriesgenerallybelievetheircapacityforassessingcreditandinterestraterisksisstrong.Thereismuchmorevariability,however,inparticipants’perceivedabilitiestomanageprice-volatilityandexchange-raterisk.

ITANDHUMANCAPACITY

Portfoliodiversificationdependsonwhetherfirmshaveemployedtalentedsecuritiesanalystswhocanassessavarietyofassetclassesanddetermineatwhatvolumetoinvestinparticularissuances.Firmsalsoneedaccesstohigh-qualityinformationtechnologytoretrieveandanalyzemarketdata,monitorbalancesheets,performriskanalytics,andexecutetradesinatimelymanner.Althoughfirmsoperatinginafrontier-marketcontextmightbeexpectedtohavelowcapacitylevels,participatingEastAfricaninstitutionalinvestorsgenerallyreportedstronginternalcapacity,bothintermsofhumanresourcesandtheirITsystems.Over80percentofrespondentsratetheirfirm’shumancapacityasgoodorexcellent.(SeeFigure7.)Only19percentdescribetheirhumanresourcesasaverage,andnofirmsratethemselvesaspoororverypoor.Assetmanagersslightlyedgeoutpensionfundsandinsurancecompaniesintheirconfidenceintheirhumancapacity.AndahigherpercentageofKenyanfirmsratetheirhumancapacityasgoodorexcellentcomparedwiththeotherEACfocuscountries.

Nearlytwo-thirdsratetheirITsystemsasgoodorexcellent.Meanwhile,30percentratethemselvesasaverageinIT,and7percentgivethemselvesaratingofpoor.Inthiscase,thereislittledifferenceamongthedifferentkindsofinstitutionalinvestors.KenyanfirmssignalmoreoptimismabouttheirITsystemsthanfirmsdomiciledinothercountries,however.Almost70percentofparticipatingKenyanfirmsratetheirITsystemsasgoodorexcellent,whereasonly62percentofUgandanparticipantssaythesame.NoRwandanrespondentsratetheirfirm’sITcapacityasexcellent,andonly43percentratethemasgood,withtheother57percentcallingtheirITsystemsaverage.OnlyoneofthethreeTanzanianrespondentsconsiderstheirfirm’sITsystemstobegood.Anotherratestheirfirm’sITcapacityasaverage,andthethirdcallstheirspoor.

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FIGURE 7. Institutional investors’ reported capacity: Human and IT systems

Overallfirmcapacity Source:MilkenInstituteCenterforFinancialMarketssurveyofEACinstitutionalinvestors

Itwouldbeexpectedthatfirmswithhigherself-assessmentsofcapacitywouldachievestrongerreturnsthanthosewithlowercapacity,andthesurveyfindingsshowthatthisconnectionbetweenreportedcapacityandreturnsdoesinfactexistinEastAfrica.Forhumancapacity,thosefirmsreportingexcellentcapacityhadanaveragereturnfor2015of10.9percent.Firmsratingtheircapacityasgoodaveragedreturnsof10.4percent,andthosesayingtheyhaveaveragehumancapacityreportedanaverageof9.5percent.Thesamepatternholdsforsystemscapacity.ThosefirmswithexcellentITcapacityreport,onaverage,returnsof12.3percentfor2015,comparedwith10.9percentforfirmswithgoodITcapacityand9.5percentforfirmsratingtheircapacityaspoortoaverage.

CAPACITYTOASSESSRISKS

Soundinvestmentdecision-makingrequirestheabilitytomonitorandassessavarietyofrisksthataffectreturns.Weaskedfirmstoassesstheircapacitytojudgetheriskfordebtdefault(creditrisk),theriskofchangesinvalueofsecuritiesduetoshiftsinforeignexchangerates(exchange-raterisk),theriskofshiftinginvestmentvaluesbasedoninterestratechanges(interestraterisk),andtheriskofsuddendropsinthemarketpriceofsecurities(price-volatilityrisk).

Capacityforassessingcreditriskandinterestrateriskisratedasgoodorexcellentby78percentand76percentofparticipants,respectively.Respondentsarelessconfidentoverallintheircapabilitiestoassessprice-volatilityrisk,withone-thirdviewingtheircapacityasaverageand9percentconsideringitpoororverypoor.(SeeFigure8.)Onlyhalfofinsurancefirmsratetheircapacitytoassessprice-volatilityriskasgood,andnoneassessthiscapacityasexcellent.Whenitcomestoassessingexchange-raterisk,70percentofrespondentsratetheirfirmsasgoodorexcellent,whileaquarterviewtheircapacityasaverage,and7percentconsidertheirabilitiestobepoor.Surprisingly,allfirmsthatviewtheircapacitytoassessexchange-rateriskaspoorcurrentlyholdassetsabroad.

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0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Creditrisk Exchange-raterisk Interestraterisk Price-volavlityrisk

%ofrespondents

VeryPoor Poor Average Good Excellent

FIGURE 8. Investors’ reported capacity to assess various types of r isk

Source:MilkenInstituteCenterforFinancialMarketssurveyofEACinstitutionalinvestors

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BOX 3. Portfol io management practices among EAC institutional investors ValueatRisk(VaR):VaRwasoriginallydevelopedbybankstomonitormarketriskontheirtradingbooks.Morerecently,ithasbeenadoptedbysomeinstitutionalinvestorstomonitorportfoliovolatility.64SurveyresponsesindicatethatVaRhasbecomeacommonrisk-managementtoolamonginstitutionalinvestorsintheEACbutnotastandardone.Amongtherespondents,63percentofassetmanagementcompaniesreportusingVaR.Participatinginsurancecompaniessplitevenlyonthisquestion.However,amongpensionfunds,justoverathirdreportusingVaR.ItisworthnotingthattheuseofVaRbyinstitutionalinvestors,particularlybypensionfunds,iscontroversial.RandleandRudolph(2014)notethatVaRiseasytoquantifyandcanserveasahigh-frequencymetric;however,“itsrelevancetolong-terminvestorsisquestionable.”Astheyalsonote,“VaRisameasureofvolatilityandprovideslittleinformationabouttheprobabilityofreachinganadequatepensionatretirementage.”65

DedicatedLiquidityPortfolios:Inmanycases,institutionalinvestorsaroundtheworldchoosetokeepacertainpercentageoftheirassetsincashorinassetsthatarereadilyconvertedintocash,tomeetexpectedandunexpectedliquiditydemands.Overall,69percentofthosewhorespondedreportedkeepingadedicatedliquidityportfolio,includinglargemajoritiesofthesurveyedpensionfundsandinsurancecompanies.Table6showstheaveragecompositionofliquidityportfoliosamongparticipatingfirms.Cashanddemanddepositscarrynoprincipalriskandarethereforebestsuitedforimmediateliquidityneeds,whereastimedeposits,governmentT-bills,andcommercialpaperaremoreappropriateforanticipatedliquidityneedsthataresomemonthsout.66Itisthereforeunsurprisingthatinsurancecompaniesandassetmanagementcompaniesallocatemoreoftheirportfoliostocash,astheyaretypicallysubjecttogreaterliquidityriskthanarepensionfunds.67

TABLE 6. Asset composition of l iquidity portfol ios

%oftotalliquidityportfolio(average)

Cash/demanddeposits

Timedeposits

GovernmentT-bills

Short-termcommercial

paper

Otherinvestments

Allrespondents

16.3% 35.5% 24.8% 3.2% 20.1%

Assetmanagement

companies14.7% 32.0% 23.0% 10.0% 20.3%

Insurancecompanies 25.1% 38.6% 19.6% 0.0% 16.6%

Pensionfunds 4.8% 33.4% 33.2% 3.6% 25.0%Note:Averagesexcluderesponsesthattotaledlessthan100%.

64Simons,“TheUseofValueatRiskbyInstitutionalInvestors,”NewEnglandEconomicReview(November/December2000).65RandleandRudolph,“PensionRiskandRiskBasedSupervisioninDefinedContributionPensionFunds,”WorldBank(2014).66KinniryandHammer,“ManagingCashinYourPortfolio,”VanguardGroup(2012).67Afewrespondentsdefined“Otherinvestments”intheirliquidityportfolioasincludinggovernmentbonds,privateequity,andrealestate—assetclassesnottypicallyconsideredappropriateforaliquidityportfolio.

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V.Cross-borderassetallocationanditsdriversIntheory,holdingforeignsecuritieswouldbeparticularlyappealingtoinvestorsbasedindevelopingcountrieswithshallowfinancialmarkets.Investingabroadgivespensionfundsandinsurancefirmsaccesstoamuchwiderrangeofsecurities,includinghigher-qualityones.Italsocanallowthemtoextendthematurityofsecuritiesheldintheirportfolios,particularlywhentherearenotenoughlong-termsecuritiesavailabledomestically.68Moreover,assetpricesabroadmaybelesscorrelatedwiththoseofdomesticmarkets,providinginvestors—andtheirbeneficiaries—somemeansofhedgingtheriskoffinancialdownturnsathome.

Portfoliodiversificationtoincludeforeignassetsisacommonrisk-managementstrategyforinstitutionalinvestorsworldwide.Inmanydevelopingcountries,however,localinstitutionalinvestorsfacetightlimitsonforeigninvestment.Examiningrestrictionsonpensionfundsinsevendevelopedmarketsandeightemergingmarkets,Chan-Lau(2004),forexample,foundthatquantitativelimitsoninvestingabroadwererelativelystricterinemergingmarkets.69Suchrestrictionsmaybeputinplaceoutofconcernsthatmayincludelocalinvestors’lackoftechnicalcapacityandexperienceininvestingabroad.70

Asdiscussedbelow,thefocuscountriesforthisstudydosetlimitsoninvestors’foreignassetallocations.However,asmembersofaregionaleconomiccommunity,thereisanaddedwrinkletocross-borderlimits.WithintheEACregion,regulatoryrestrictionsaregenerallylooser—andsometimeslackingaltogether.Thatis,forcertainassetclasses,investorsarestillsubjecttoassetallocationrestrictionsbutarenotsubjecttoanyadditionalcross-borderrestrictionsforinvestmentswithintheEAC.Asmostpolicymakersrecognize,regionalcooperationand,ultimately,integrationoffinancialmarketscanbeanimportantsteptoachievingdeeper,moreliquidcapitalmarkets.71Forgingcloserregionallinks—includingthroughcross-listingsandcross-borderinvestment—mayofferawayforsmall,lessdevelopedcapitalmarketstoachieveneededscale.

Possiblebenefitsassociatedwitharegionalapproachtocapital-marketdevelopmentincludediversifiedriskinawidermarket,moreefficientandcompetitivemarkets,lowercosts,andmoreopportunitiestogeneratereturns.Bypoolingtheresourcesofsmalllocalcapitalmarkets,regionalizationcanboostliquidityandtheabilityofthesemarketstointermediatecapitalforprivate-sectorandinfrastructuredevelopment.72Institutionalinvestorswouldgainaccesstoabroaderrangeofsecurities.Likewise,issuerswouldgainaccesstoalargernumberofinvestors.

68Beck,Maimbo,Faye,andTriki,“FinancingAfrica:ThroughtheCrisisandBeyond”(2011).69Chan-Lau,“PensionFundsandEmergingMarkets,”IMFWorkingPaper04/181(Washington,DC:IMF).Inasurveyofinstitutionalinvestorsin21developingcountries,IOSCOfoundthatsevenjurisdictionsrequiredpriorauthorizationtoinvestabroad,and12imposedlimitsonforeigninvestments.SeeIOSCO,“DevelopmentandRegulationofInstitutionalInvestorsinEmergingMarkets”(2012).70Beck,Maimbo,Faye,andTriki,“FinancingAfrica:ThroughtheCrisisandBeyond”(2011).Theymayalsobemotivatedbyadesiretorestrictcapitaloutflows;seeIOSCO,“DevelopmentandRegulationofInstitutionalInvestorsinEmergingMarkets”(2012).71See,e.g.,Warden,“VirtuousCircleforEastAfrica:RegionalCapitalMarketIntegrationIstheOnlyOption”(2015),TheBulletin,Vol.6,Ed.4(London:OfficialMonetaryandFinancialInstitutionsForum).72SeeIrving,Jacqueline,“RegionalIntegrationofStockExchangesinEasternandSouthernAfrica:ProgressandProspects”(2005),IMFWorkingPaper05/122(Washington,DC:IMF).Liquidityisoneofthemostessentialelementsforastronglink

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ThesectionthatfollowsdescribesthreetypesofconstraintsthatinstitutionalinvestorsintheEACmayfacewhentheyconsiderdiversifyingtheirportfoliosbeyonddomesticmarkets.First,theseinvestorsoperateundernationalregulatorylimitsonforeigninvestments,bothwithintheEACmarketandbeyond.Second,boardsandinvestmentcommitteesapplytheirowninternalguidelinesthatmaylimitallocationsinotherjurisdictionsbeyondnationalrestrictions.Third,investorsmaylackhedgingsolutionsneededtoadequatelymanageexchange-raterisk.Thissectionclosesbyexamininginvestors’actualportfolioallocationstoforeignassetsandthereportedmotivesbehindtheseinvestments.

A.Regulatorylimitsonintraregionalandothercross-borderinvestment

Itiscommonforinstitutionalinvestorsindevelopingcountriestofacelimitsontheirforeignassetholdingsforreasonsthatcanincludecapacitylimitationsofregulators,aswellasinvestorsandfinancialintermediaries.(Seeabove.)73EACmembers’nationalregulatorsgenerallyfollowthistrend—certainlyinhowmembercountries’regulateinvestmentbylocalpensionfundsandinsurersoutsidetheEACitself.FromthestandpointofEACnationalregulators,allcountriesoutsidetheEACareconsideredforeign,while,atleasttheoretically,otherEACmemberstatesshouldbeconsidereddomesticinvestmentsunderthe2010EACCommonMarketProtocol.Inpractice,however,nationalregulatorshaveflaggedsomeassetclasseswhereotherEACcountriesasplaceofdomicilearetreatedas“foreign,”whileothersaretreatedas“domestic.”

Table7showshowpensionfundregulatorsinKenya,Tanzania,andUgandatreatdifferentassetclassesdomiciledinotherEACcountries.Forexample,KenyanregulatorstakeaparticularlymixedapproachacrossdifferentassetclassesdomiciledinotherEACcountriesastowhetherpensionfundinvestmentsinthoseassetswouldbeconsideredforeignordomestic.

TABLE 7. Regulatory view of pension fund investments across asset classes in EAC countries other than where the fund is domici led

Government* Bankdeposits

Corporatebonds

Realestate

Publicequities PE/VC

Bills BondsKenya Domestic Foreign Domestic Mixed** Domestic Foreign

Tanzania Domestic Domestic Domestic Domestic Domestic NotaddressedUganda Domestic Domestic Domestic Mixed** Domestic Domestic

*Regulatoryrestrictionsforgovernmentdebtapplytobothgovernmentbillsandbonds.**TheKenyaandUgandaregulatoryregimesconsiderallREITswithintheEACasdomesticinvestmentsandimmovablepropertyinvestmentsinotherEACcountriesasforeign.Sources:RegulatoryauthoritiesinKenya,Tanzania,andUganda

Whereassetsareconsideredforeignforregulatorypurposes,Kenya’sregulatorshaveplacedtightlimitsontheshareofpensionandinsuranceportfoliosthatmaybeinvestedinforeignsecurities.(SeeTable8.) betweenstockmarketdevelopmentandlong-termeconomicgrowth.See,e.g.,Levine(1991),whoarguesthatliquidstockmarketscanencouragemoreinvestmentinhigh-returnprojectsthatrequirelong-termcapitalcommitments.73Beck,Maimbo,Faye,andTriki,“FinancingAfrica:ThroughtheCrisisandBeyond”(2011).Theymayalsobemotivatedbyadesiretorestrictcapitaloutflows;seeIOSCO,“DevelopmentandRegulationofInstitutionalInvestorsinEmergingMarkets”(2012).

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TanzaniaandUganda,however,goevenfurther.Tanzaniadoesnotpermitlocalinstitutionalinvestorstoinvestabroadatall.InRwanda,theregulationsdonotspecifylimitsforinvestmentinforeignassets.TheRwandanSocialSecurityBoard’sinternalguidelinesincludemaximumtacticalpolicyweightsforforeignallocations.Forforeignequities,themaximumtacticalpolicyweightis25percent.Forregionalfixedincome,itis20percent,whileforforeignfixedincome,itis10percent.TheRSSBplacesafewadditionalrestrictionsonitsforeigninvestments,includinga50percentlimitontheshareoftheoffshoreportfoliothatcanbecontrolledbyasinglefundmanager.

TABLE 8. Limits on foreign investment by EAC institutional investors

Maximumallowed(%oftotalAUM)

Pensionfunds Insurancecompanies

Kenya* 15% 5%Tanzania 0% 0%Uganda 5% 0%

Rwanda(RSSB)25%inequities

and10%infixedincome 100%

*Kenyanrestrictionsoninsurancecompanyassetallocationsarestillindraftform.Sources:RegulatoryauthoritiesinKenya,Tanzania,Uganda,andRwandaandRSSBIntra-EAClimitsimposedoninsurancefirmsvaryevenmorebycountry.Kenya’sdraftinvestmentguidelinesforlocalinsurancefirmssetamaximumportfolioallocationof5percentforforeigninvestments.However,theguidelinesdonotspecifywhetherinsurers’investmentsinassetsinotherEACcountrieswouldbeconsidereddomesticorforeignforthepurposeofthisceiling.Surprisingly,Rwanda’sinsuranceregulationsplacenoexplicitrestrictionsontheabilityoflocalinsurancefirmstoinvestinforeignassets,whetherinsidetheEACoroutsideit—meaningthat,atleastintheory,localinsurersfacenospecificrestrictionsonforeigninvestment.RegulationsinTanzaniaandUgandadonotallowinsurerstoinvestabroadatall,evenwithintheEAC.However,inTanzania’scase,thisrestrictionisexpectedtobeeasedforintra-EACinvestmentsbymid-2017.74

B.Internalguidelinesoncross-borderinvestmentswithintheEAC

Inadditiontonationalregulatoryrestrictions,institutionalinvestorsthemselvesoftensetinternallimitsontheirintra-EACinvestment,aspartoftheirlargerportfoliostrategy.Notably,theseinternalguidelinesoftenviewassetallocationstootherEACmarketsasforeigninvestments,evenwhenregulatorswouldconsiderthemdomestic.Andinactuallymanagingtheirportfolios,manysurveyedinvestorsaretakingastillmoreconservativeapproachthanthatprovidedforininternallysetguidelines,fallingwellshortoftheirfirms’ownmaximumtargetsinholdingassetsdomiciledoutsidetheirowncountries.

74CorrespondencewithTIRAstaff.

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RoughlyhalfofinstitutionalinvestorsintheEAChaveinternalguidelinesthattreatinvestmentsinotherEACcountriesasforeign.Surveyedfirmstendtofallwellshortofceilingssetbytheirownfirms’internalguidelinesinholdingassetsinnon-localEACcountries—includingforkeyassetcategoriesthatcouldhelpdiversifytheirportfolios.

Intermsoftheirinternalguidelines,participatinginstitutionalinvestorsaredividednearlyequallyonwhethertheyregardassetclassesinotherEACcountriesasdomesticorforeigninvestments.Aslightlysmallerproportion(45percent)ofparticipatinginstitutionalinvestorsregardalloftheEACasdomestic.

Morethanhalfofsurveyedfirmsrelyonacombinationofregulatorthresholdsandinternalguidelinesindeterminingthresholdsforassetclassesdomiciledinnon-localEACmarkets.Onein10participantsreliesmoreoninternalguidelinesindeterminingthresholdsforassetclassesinnon-localEACmarkets.

Anumberofsurveyedfirmsspecifiedtheinternalceilingstheyapplytointraregionalinvestmentsinvariousassetclasses.Ceilingsforgovernmentbondsrangewidely,from10percentto50percentoftheportfolio,whilecorporatebondmaximumsaresetat5percentto15percent.Mostofthesefirmscapintraregionalpublicequityallocationat15percent,thoughonefirmhassetitashighas40percent.Onlyafewfirmshaveguidelinesonmaximumallocationtoprivateorunquotedequity,andtheseportfoliothresholdsrangefrom5percentto20percent.

Internalthresholds,however,donotmeanthatfirmshavemadeinvestmentsintheseassetclasses.AmonginstitutionalinvestorsbasedinEACfocuscountries(excludingRwanda75)thatinvestinassetsintraregionally,88percentthatsetinternalceilingsonholdingsingovernmentbondsissuedbyotherEACcountriesholdnothinginthisassetcategory.Meanwhile,Kenya’snationalregulationsspecifyaceilingashighas90percentofassetsforpensionfunds’investmentingovernmentsecuritiesissuedbyotherEACcountries.

NoneoftheinstitutionalinvestorsthatsetinternalceilingsontheportionoftheirportfolioheldincorporatebondsissuedinotherEACcountriesareholdinganyoftheirassetsinthesesecurities.Theseceilingsrangefrom5percenttoashighas15percent.AsfourofthesefirmsarebasedinKenyaandthefifthisbasedinUganda,thiscouldreflectthelackofproductinnon-localEACcapitalmarkets.

Thisseemstobeatrendacrossassetcategories—evenveryliquid,low-riskassetssuchasdemandandtimedeposits.Thevastmajorityofinstitutionalinvestorsthathavesetthresholdsfortheportionofassetsheldintheseassetcategoriesdomiciledinnon-localEACcountriesareholdingnothinginthesecategories.Forthesemoreliquid,lower-yieldingassets,concernsmaycenteronwhetherthevalueofrepatriatedyieldsmeritstheinvestment,especiallywheretheremaybesomeuncertaintyabouthowtheseinvestmentsareregardedfromaregulatorystandpoint.Andnationalceilingsarerelativelylowfortheseassetcategoriesanyway,evenwhenwithintheEAC.(Seeabove.)Forbondsandlessliquidsecurities,institutionalinvestorsmaynotbetakingtheseupintraregionallyduetothegenerallackofproductandconcernsaboutilliquidity/exit,aswellasuncertaintyabouthowrestrictionsapply.

75TherewereonlytwoRwandaninstitutionalinvestorsthatindicatedtheyinvestedinassetsdomiciledoutsideofRwanda,andthesefirmsdidnotindicatetheactualormaximumamountsallowedtobeinvestedinassetclassesdomiciledinotherEACcountries.Forthisreason,theanalysisinthissectionexcludedRwandaninstitutionalinvestors.

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Forlistedequities,however,thistrendislessprominent,althoughstillpresent.HalfofinstitutionalinvestorsbasedinEACcountries(excludingRwanda)thatreportsettingthresholdsforassetsheldinequitieslistedonnon-localEACmarketsholdnoneoftheirassetsinthesesecurities.Theceilingis15percentineachofthefourcaseswhereinstitutionalinvestorsdoholdsomeoftheirportfoliosinthisassetcategory,withtheactualamountsinvestedrangingfrom3percentto6percent.

SettinginternalceilingsforassetsheldinunquotedprivateequityissuedbyentitiesdomiciledinotherEACcountriesislesscommon—onlyfourinstitutionssetsuchceilingsintheirinternalguidelines,andtheyrangefrom5percentto20percent.Onlyonefirm,however,actuallyallocatesassetstothiscategory,at5percentoftotalassets(againsta20percenttarget).Thelackofattentiontothisrelativelynewassetclassininternaltargetsettinglikelyreflectsthefactthatnationalregulationsarestillemerging,aswellastheoveralllackofavailableproductandmorelimitedevaluationcapabilities.

AVAILABILITYOFCURRENCY-HEDGINGINSTRUMENTS

AthirdmainpotentialconstraintthatinstitutionalinvestorsintheEACmayfacewhentheyconsiderdiversifyingtheirportfoliosbeyonddomesticmarketsisalackofthehedginginstrumentsneededtoadequatelymanageexchange-raterisk.Giventhesurveyfindingsabovethat,indiversifyingtheirportfoliosbeyonddomesticmarkets,investorsoftenfallfarshortofceilingsthatapplyinternallyaswellasthoseimposedbyregulators,thismaybeamuchmoresignificantimpedimentthanquantitativerestrictionsandtargets.

Aswewouldexpect,alackofhedginginstrumentsandstrategiesformanagingforeigncurrencyriskdoesseemtoimpedetheabilityofinstitutionalinvestorstotakeamorediversifiedportfolioapproachintraregionally.Nearlythree-quartersofparticipatingfirmssaidtheydidnothaveaccesstothecurrency-hedgingstrategiesandinstrumentstheyneedtoadequatelymanageforeigncurrencyrisk.Comparedwithinvestorsinothermemberstates,Kenyanfirmsaremorelikelytopossesssolutionsforcurrencyrisk.AlmosthalfofparticipatingKenyanfirmsreporttheyhaveaccesstohedgingsolutions,comparedwith29percentofRwandanfirmsandonly13percentofUgandaninstitutionalinvestors.NoneofthethreeTanzanianrespondentshavethetoolstheyneedtohedgeforeignexchangerisk.Aboutone-thirdofassetmanagersandinsurancecompaniesreporttheyhaveaccesstohedgingtools,butonly6percentofsurveyedpensionfundscansaythesame.

AlargepercentageoffirmswouldlooktoincreaseinvestmentsinneighboringEACcountriesiftheyhadaccesstobettersolutionsformanagingforeignexchangerisk.Over40percentofKenyanfirmsandhalfofparticipatingUgandaninvestorswouldbemorelikelytoincreaseinvestmentintoRwandainparticularifforeignexchangehedgingproductsweremorewidelyavailable.Nearlythree-quartersofthissubgroupofrespondentsalreadyinvestsinassetclassesoutsidetheirhomecountries.AmongRwandanfirms,threeoutofthesevenrespondentssaidtheywouldbemorelikelytoincreaseinvestmentsintootherEACcountriesiftheyhadbetteraccesstoforeignexchangehedgingproducts.Twoofthesethreecurrentlyinvestinassetsoutsideoftheirhomecountries.

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Whenaskedwhattheirfirmsneedtobettermanageforeigncurrencyrisk,EastAfricaninstitutionalinvestorsmostfrequentlysaytheywanttoseethedevelopmentofalocalderivativesmarket.AKenyanparticipantnotesthattheseproductsarecurrentlybeingdevelopedintheregion.SomeKenyancommercialbanks,forexample,offerclientsbasicforwardcontractsandcurrencyswaps.76AUgandanrespondent,though,anticipatestheneedforregulatorychangesbeforehedgingcontractsbecomewidelyavailable.Alongwithwantingtoseenewproducts,severalparticipants,includingtwoRwandanfirms,indicatetheyneedtobuildcapacitywithintheirfirms,throughtraining,increasedawareness,andtappingexternalexpertisethroughhiringoutsideserviceproviders.AsdiscussedinSectionIV,30percentofrespondentsratetheirfirms’abilitytoassessexchange-rateriskasaverageorpoor.

Notably,severalsurveyrespondentsexplicitlycitemanagingcurrencyriskand-orbenefitingfromcurrencymovementsasmotivationfordiversifyingtheirportfoliointoassetsheldabroad.TwentypercentoftheUgandanfirmsthatinvestinassetclassesinKenyaareseekingtobenefitfromexchange-ratemovements,evenasKenyanfirmsindicatesimilarmotivesforinvestingoutsidetheEAC.AsshowninFigure9,theUgandanshillinghassteadilyweakenedagainsttheKenyanshillingoverthelastfewyears,whileKenya’scurrencyhasfalleninvalueagainsttheU.S.dollar.Aboutone-tenthoftotalsurveyedrespondentsexplicitlyreporthavingsoughttoprofitfromcurrencymovements.

ACTUALFOREIGNALLOCATIONOFEASTAFRICANINVESTORS

Halfofrespondentsreportinvestinginassetsbeyondtheirhomecountries—thatis,assetsdomiciledinotherEACcountriesand-ormarketsbeyondthesubregion.Theseallocationsrangewidely,from2percentto89percentoftotalportfolio.Thenumberholdingforeignassetsmayincreaseincomingyears,asanadditional24percentofrespondentssaytheyintendtomakeforeigninvestmentsinthefuture.Another7percenthaveheldforeignassetsinthepastbutdonotcurrently.Aboutone-fifthofrespondentshaveneverinvestedbeyondtheirhomemarketsandhavenoplanstodoso.

UgandaninstitutionalinvestorsoverallaremostlikelyamongtheEACfocuscountriestoholdassetsdomiciledoutsidetheirhomecountry.Nearly70percentofsurveyedUgandaninvestorshaveallocatedfundstoassetsoutsidethecountry,comparedwith50percentofKenyanfirms.(SeeFigure10.)OnlytwoofthesevenparticipatingRwandanfirmshaveassetholdingsabroad,whilenoneoftheTanzanianinvestorsdo.AssetmanagersaremorelikelytohaveinvestedabroadthanotherEastAfricaninstitutionalinvestors.Nearly90percentofsurveyedassetmanagersholdforeignassets,comparedwith65percentofsurveyedpensionfunds.Asmightbeexpected,giventhattheygenerallyfacetighterorstill-emergingrestrictionsoninvestmentinnon-localassets,only13percentofparticipatinginsurancefirmsacrosstheEACinvestinassetsbeyondtheirhomecountries.

76See,e.g.,BusinessDaily,“CBKSetsRulesforHedgingShillingSwings”(June19,2012).

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0.026

0.0285

0.031

0.0335

0.036

9/3/12 9/3/13 9/3/14 9/3/150.009

0.01

0.011

0.012

0.013

9/3/12 9/3/13 9/3/14 9/3/159/3/16 9/3/16

FIGURE 9. Recent exchange-rate trends: Ugandan shil l ings to Kenyan shil l ings and Kenyan shil l ings to U.S. dollars

Dailybuy/sellmean,September3,2012,toAugust31,2016

UGX/KES(Sept.2012-Aug.2016)

Source:CentralBankofKenya,https://www.centralbank.go.ke/rates/forex-exchange-rates/

AssetsdomiciledinKenya’smarketsarethemostcommon—and,insomecases,thesole—destinationforforeigninvestmentsofUgandanandRwandansurveyparticipants.Non-Kenyan-basedinstitutionalinvestorsareattractedbyKenya’smoredevelopedcapitalmarketsandrelativelymoreavailablefinancialproducts.Oursurveyfindingsconfirm,unsurprisingly,thatamainmotiveisaccesstoKenya’smoredevelopedandliquidequitymarket.

TheKenyanmarketsappeartobeparticularlyattractivetoUgandanfirms.Eachofthesurveyedfirmsthathasinvested20percentormoreofitsportfolioinforeignassetsisdomiciledinUganda,andtheseinvestorshavedirectedalmostalloftheirnon-domesticallocationstoKenya.OneUgandanfirm,forexample,hasinvestedasmuchastwo-thirdsofitsportfolioinKenya,andasmallUgandanpensionschemehasallocatedhalfitsportfoliotoKenyanfixed-incomesecurities.AccordingtoaportfoliomanagerwithoneUgandan-basedinvestorholdingallitsnon-localassetsinKenya’sequitiesmarket,Kenyaisamoreactiveeconomywithaliquidstockmarket,andhisfirmwantstoparticipateinthatcounty’seconomicgrowth.ThissamerespondentnotedthatKenyaninvestmentsarefacilitatedbythe

KES/USD(Sept.2012-Aug.2016)

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0%

10%

20%

30%

40%

50%

60%

70%

80%

Uganda Kenya Rwanda Tanzania

%ofrespondents

factthatUganda’sregulatorconsidersotherEACmarketsas“local”forassetmanagementpurposes.77AnotherUgandaninvestorsaidhewasspecificallyattractedbytheREITestablishedinKenyalastyearandlistedonthestockexchange.SeveralUgandanfirmsalsocitedtheopportunityforenhancedreturnsasacriticalmotivationfortheirforeigninvestments.

FIGURE 10. Ugandan f irms are most l ikely to hold non-local assets—attracted by access to Kenya’s more developed market

Percentageofsurveyedinstitutionalinvestorsbyhomecountrythatholdnon-localassetsSource:MilkenInstituteCenterforFinancialMarketssurveyofEACinstitutionalinvestorsWhereasUgandanfirmswantaccesstodeeper,moreliquidmarkets,Kenyanfirmsaremorelikelytoexplicitlyreferencesimplediversificationasamotiveforforeignassetallocation.Outof12surveyedfirmsthatexplicitlycitediversificationasaprimarymotiveforinvestingabroad,eightaredomiciledinKenya.Inadditionto“generaldiversification,”thesefirmsspecificallyreferto“countrydiversification,”“sovereigndiversification,”and“diversifyingawayfromKenyan-specificrisk.”78AccordingtooneKenyan-domiciledrespondent,lowcorrelationofotherEACmarketstoKenya’smarketgivesaccesstoimprovedliquidityandportfoliodiversificationandcanenabletheportfoliotobenefitfromcurrencymovements.SharepricesontheNairobiSecuritiesExchange,afterpostingstronggainsfrom2012to2014,havefalleninvalueoverthelasttwoyears.

About20percentofthesampleholdassetsoutsidetheEAC.MostofthesefirmsareKenyanassetmanagers,andtheyhaveallocated3percentto7percentoftheirportfoliostofinancialassetsbeyondtheEAC.Theydescribetheseallocationsasinvestmentsininternationalfundsdedicated,forexample, 77SeeSectionVforadiscussionofactualrestrictionsbyassetcategoryonportfolioholdingsoutsideaninstitutionalinvestor’sdomicilecountry.78Standard&Poor’sloweredKenya’screditratingtonegativefromstableinOctober2016duetoelevatedrisksfromcurrencydepreciationandawideningbudgetdeficit.Seehttp://x254.co/standard-poors-lowers-kenyas-credit-rating-outlook-from-stable-to-negative/.

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toEuropeanequitiesorexposuretoemergingmarkets.OneKenyanfirmhashiredFranklinTempletontomanage5percentofitsassetsinoffshoresecurities.AnotherKenyanassetmanagementcompanyinvests3percentofitsportfolioinAfricanstockexchangesoutsidetheEAC.Outofallsurveyedinstitutionalinvestors,thefirmthathasallocatedthelargestpercentageofitsportfoliotoassetsoutsidetheEACfocuscountriesisaUgandanfirmthatinvests23percentofitsfundinMalawiandSouthSudan.79

ThoughKenyanfirmsmorefrequentlyinvestbeyondtheregion,themajorityofassetsthesefirmsholdoutsideofKenyastayswithintheEAC.Intermsofvalue,investmentsintootherEACcountriesequal69percentoftotalforeigninvestmentsreportedbyparticipatingKenyanfirms,withUgandathemostcommondestination.Itissignificantthatthemajorityofnon-domesticassetsheldbyKenyaninstitutionalinvestorsremainwithintheEAC.Kenyaninvestorsrepresentthebulkofinstitutionalsavingsfortheregion,andpolicymakersincountrieswithsmallerfinancialmarketshopetotapintothispoolofsavingsastheirmarketsgrow.

VI.ThebuysideforRwanda:HowcanRwanda’scapitalmarketsattractinstitutionalinvestorsacrosstheEAC?ForgingcloserregionallinksacrosstheEAC’scapitalmarketsmayofferawayforsmall,lessdevelopedcapitalmarketstoachieveneededscale.ThisisparticularlytrueinthecaseofRwanda,wherepolicymakershavelauncheda10-yearcapital-marketmasterplanthatemphasizesaregionalapproach.Policymakersareacutelyawareoftheimportanceofattractingtherightkindofdevelopment-enhancingforeigncapitalandhaveemphasizedintheirregionalintegrationaimsthepotentialforsourcingmorelonger-termcapitalintraregionally,particularlyfromKenya.

Rwanda’spolicymakersalsorecognizethatprogresstowardregionalcooperationandintegrationofcapitalmarketsmayactuallyhelpspuracceleratedeconomicintegrationgoalsinotherareas.Forexample,theharmonizationofstockmarketregulationsandtradingpracticesthataccompaniesregionalizationcoulddeepenregionalintegrationmorebroadlyinpolicyareassuchastaxation,accountingstandards,corporategovernance,andlegalpractices.80Andincreasedregionalcooperationandmarketintegrationmayfacilitatethefinancingofcross-borderinfrastructureprojects,suchastheEAC’sNorthernCorridor,whichincludesKenya,Uganda,andRwanda.

Inmanyways,Rwandarepresentsaninterestingcasestudyoftheabilityofasmall,developingcountrytoattractforeigninvestment,particularlyfromneighboringcountriesbelongingtothesameregionaleconomiccommunity.Withitsdomesticinstitutionalinvestorbasecurrentlyverysmallanditsownfinancialmarketsattoonascentastagetomeetthecountry’spressingneedsforlong-termdevelopmentfinance,itmustlookfartherafield.Kenya’sfinancialmarketismuchlargerandmoredevelopedthanRwanda’sandthoseoftheotherEACcountries,andKenya’sinstitutionalinvestorstend

79SouthSudanaccededtotheEACinApril2016.Uganda,Malawi,andSouthSudan(asofMay2016)areallalsomembersoftheCommonMarketforEasternandSouthernAfrica(COMESA),anotherregionaleconomiccommunity.80Okeahalam,CharlesC.,“StrategicAlliancesandMergersofFinancialExchanges:TheCaseofSADC”(March2005),JournalofSouthernAfricanStudies,Vol.31,No.1.

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tohavesignificantlylargerassets.ThechallengesRwandafacesinattractingcross-borderinvestmentfromitsEACneighbors—andhowitovercomesthosechallenges—mayhaveusefulapplicationsforothersmall,developingcountriesinAfricaandotheremergingregions.

A.WhatstopsinvestorsattheRwandanborder?

Accordingtothesurveyfindings,RwandaisstrugglingtoattractlargeamountsofinvestmentfrominstitutionalinvestorsdomiciledinotherEACcountries.Only16percentofEACfirmsdomiciledoutsideRwandareportinvestinginRwandanassets.ThisgroupincludestwoKenyanandtwoUgandanfirmsbutnonefromTanzania.Amongthesefirms,investmentsinRwandan-domiciledassetsrangefromjust0.3percentupto10percentoftotalAUM.Indollarfigures,theseinvestmentsadduptoabout$45million,orlessthan0.5percentoftotalAUMreportedbyparticipatingKenyan,Tanzanian,andUgandanfirms.Moreover,theserespondents’investmentsinRwandaarelimitedtoonlytwoassetclasses,withapproximately$8millioninvestedinshareslistedontheRwandaStockExchange(RSE)andasmuchas$37millioninvestedinrealestate.Surprisingly,especiallyinlightoftheNationalBankofRwanda’snewregularissuanceprogram,noEACinstitutionalinvestoroutsideRwandareportsinvestinginRwandangovernmentsecurities.

TounderstandthepotentialobstaclestofurtherparticipationinRwandanmarkets,oursurveyaskedaseriesofquestionsaboutwhyRwandamaybeunattractive—orattractive—asaninvestmentdestination.ItisimportanttonotethattheseareperceptionsandthatthefindingsoutlinedbelowdonotnecessarilyimplythattheperceivedbarrierstoinvestmentaremorepronouncedinRwandarelativetootherEACmemberstates.

InstitutionalinvestorsfromotherEACcountriesranklowlevelsofliquidity,lackofinvestableproduct,andconcernsaboutmarketinfrastructureasthemostsignificantbarrierspreventingthemfromincreasinginvestmentinRwanda.Nearly60percentofnon-RwandaninstitutionalinvestorsidentifymarketliquidityasahighlysignificantbarriertoinvestinginRwandanmarkets,asshowninFigure11.Nearly70percentoftheseinvestorsareKenyan-domiciled,andthevastmajorityofthesearepensionfundsorassetmanagers.AmongthoseTanzanianandUgandaninvestorsthatcitedlowliquidityasasignificantimpediment,80percentarelikewisepensionfundsorassetmanagers.81Asmanyas44percentofparticipatingnon-Rwandaninstitutionalinvestorsconsiderthelackofinvestablesecuritiesamajorbarrier,and26percentfindmarketinfrastructureamajorbarrier.

Amajority,57percent,ofinstitutionalinvestorsinotherEACcountriesidentifycurrency-conversionfeesasamajordiscouragementtotheirparticipationinRwandanmarkets.Anadditional19percentsaythatforeignexchangeandcurrency-conversionfeesdiscouragedtheirinvestmentinRwandatosomeextent.RespondentsratethesefeesasmorediscouragingthananyothercostsassociatedwithinvestinginRwandansecuritiesmarkets.Nearlyone-quarterofEACinstitutionalinvestorsoutsideRwandaflagexposuretotheRwandanfrancasaTop3barriertoinvestinginRwandancapitalmarkets.Notably,themajorityofthosefirmsthatdoinvestinRwandanassetsreportthatforeignexchangeandcurrency-

81Notably,thelackofmarketliquidityisthemost-citedchallengefacingRwandaninvestorsaswell.

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conversionfeesneverthelessdiscouragetheirinvestmentinRwandatoalargeextent.ThesefindingsaredirectlyrelatedtothegenerallackofhedginginstrumentsdiscussedinSectionV,asmostofthesefirmsreporttheydonothaveaccesstothehedgingsolutionstheyneed.

Amajorityofsurveyedfirmsalsoreportthatcustodianfees,centraldepositorysystemfees,andtradingfeesdiscourage,atleasttosomeextent,theirparticipationinRwandancapitalmarkets.Notably,however,71percentsaybrokercommissionsontradesdidnotdiscouragetheirinvestmentinRwandaatall.Likewise,65percentarenotatalldiscouragedbybid-askspreads.

Somewhatsurprisingly,giventheRwandancapitalmarket’srelativenewnessandlevelofdevelopment,only4percentofnon-RwandanEACrespondentsseeaweakinformationenvironmentoralackofinvestorprotectionasasignificantbarrier.Noneofthesurveyedfirmsidentifylowlevelsofcorporategovernance,anunattractiveregulatoryregime,orthecostoftradingcommissionsandfeesassignificantbarriers.Ontheotherhand,theareasofthecorporategovernanceandlegalenvironmentthatneedthemostimprovement,accordingtoEACinstitutionalinvestorsoutsideRwanda,arewillingnessofexecutivestoengagewithinvestors(citedasapriorityby60percentofthisgroup),disclosurestandards(citedby56percent),andminorityshareholderrights(citedby48percent).

BOX 4. Rwanda’s market needs more investable securit ies DevelopmentofalocalcapitalmarketinRwandahasbeenpartlyhinderedbyacombinationofreluctance,inability,and-orlackofawarenessbymorelocalfirmstoissuesecuritiesandlist.Rwanda’scapitalmarketscurrentlyaresmallandilliquid,withjustthreefirmshavingshareslistedandonecompanyhavingissuedabondsofar.

Manyfirms,especiallythesmallandmedium-sizedenterprises(SMEs)thatmakeupthevastmajorityofthecommercialsector,lackthescale,resources,andcapacitytoissueonthecapitalmarkets.82Inadequatecapacitytomeetfinancialreportingrequirementsforlistinghasimpededmanyfamily-ownedfirmsinaccessingcapitalmarketsinRwanda.Buttherealsoisaneedformorefinancialeducationandgreaterawarenessofthecapitalmarketasafinancingoptionforthoselocalfirmsthatcouldlistorbecomepartofapipelineofcompaniesforlaterlisting.83

Theresultingshortageofinvestablesecuritiesimpedestheabilityofcapitalmarketstoattractinvestors,locallyandintraregionally.Thelackofinvestorinterestthenbecomesamajorobstacletoattractingnewissuers,resultingina“chickenandegg”dilemmaimpedingfurthermarketdevelopment.

82Sau,MoutusiandJohnSchellhase,“SurveyBrief:RwandanBusinessesShareTheirPrioritiesforCapital-MarketDevelopment”(2015)(Washington,DC:MilkenInstitute).83Irving,Schellhase,andWoodsome,“FramingtheIssues:DevelopingCapitalMarketsinRwanda”(2016)(Washington,DC:MilkenInstitute).

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B.WhatmakesRwandaattractivetoinvestors?

ThemostattractiveaspectsoftheRwandanmarketstooutsideinvestorsaretheeconomy’sstrongrecordofgrowth,anattractiveregulatoryenvironment,andmacroeconomicstability.OverhalfoffirmsfromotherEACcountriesranktheeconomy’sstrongrecentexpansionasoneofthemostattractivefeaturesofinvestinginRwanda,withanadditional35percentidentifyingtheattractivenessofthecountry’smacroeconomicstability.Over40percentsaythatRwanda’sattractiveregulatoryenvironmentisoneofitsmostcompellingaspectsasaninvestmentdestination.Aboutone-quarterofnon-RwandansurveyparticipantsconsiderRwandaattractivebecauseitrepresentsanopportunityforportfoliodiversification.Figure11summarizestheseperceptionsandothers.

Askedtorankthebest-performingaspectsofcorporategovernanceandthelegalenvironmentinRwanda,85percentofrespondentsbasedoutsideRwandaacknowledgethelowlevelsofcorruptionthere.AsshowninFigure12,morethanhalfofEACfirmsalsofindRwandanregulatorstoberesponsive.Amongparticipatingfirms,thelowest-rankedaspectsoftheRwandancorporategovernanceandlegalenvironmentwereaccesstothecourts,minorityshareholderrights,andinvestorrightsgenerally.

RwandanparticipantsgenerallymirrortheviewsoftheirEACneighbors.FouroutofsevenparticipatingRwandanfirmsrankmacroeconomicstabilityasthemostattractiveaspectofthelocalinvestmentenvironment.ThemajorityofRwandanrespondentsalsoagreethatlowlevelsofcorruptionandtheresponsivenessofregulatorsareappealingaspectsoftheircountry’smarkets.Itisworthnotingthattheseviewsalsotrackcloselywithindependentassessments.TheCorruptionPerceptionsIndex,forexample,asproducedbythenonprofitgroupTransparencyInternational,ranksRwandaasthe44th-leastcorruptcountryintheworld.84ThenimbleapproachofRwandanpolicymakersinimplementingreformshasbeenwelldocumented.OnefrequentlycitedexampleoftheresponsivenessofRwandangovernmentofficialsistherapidriseofthecountryontheWorldBank’sDoingBusinessindex.85In2008,Rwandaranked150thworldwideonthisindex.Afteratargeted,deliberativeefforttoimproveitsscoresacrosstheWorldBankindicators,Rwandatodayranks56thworldwide,despiteitssmallsizeandstill-lowlevelsofeconomicdevelopment.

84TransparencyInternational,“CorruptionsPerceptionIndex2015”(2016).85WorldBankGroup,“DoingBusiness2017:EqualOpportunityforAll,14thEdition”(2016).

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0% 10% 20% 30% 40% 50% 60%

Mostazracvve

Second-mostazracvve

Third-mostazracvve

Macroeconomictrackrecordofgrowth Regulatoryenvironment Macroeconomicstability Opportunityforportfoliodiversification Stronginvestorprotection

Highcorporategovernancestandardsandcompliance Exposuretohighgrowthinaparticularindustry Stronginformationenvironment ExposuretotheRwandanfranc Higherratesofreturn Strengthofgovernmentinstitutions Filingrequirementsforissuers

0% 10% 20% 30% 40% 50% 60%

Mostsignificantbarrier

Second-mostsignificantbarrier

Third-mostsignificantbarrier

Lackofinvestiblesecurities Capital-marketinfrastructure(tradeexecutionandcustody)

ExposuretotheRwandanfranc

Lowlevelsofmarketliquidity

Lowerratesofreturnthanthoseavailableinmydomesticmarket

InvestinginRwandansecuritiesdoesnotsufficientlydiversifymyportfolio

WeakeningRwandaneconomy

Filingrequirementsforissuers

Withholdingtaxforforeignportfolioinvestorsistoohigh

Capitalgainstaxesaretoohigh

Poorinvestorprotection

Weakinformationenvironment

Note:SurveyparticipantsinKenya,Tanzania,andUgandawereaskedtoselectthethreemostattractiveaspectsofandthreemostsignificantbarrierstoRwanda’sfinancialmarkets.Thechartsaboveaggregatetheirresponses.

FIGURE 11. How EAC institutional investors view Rwanda’s f inancial markets

AttractionsofinvestinginRwanda

BarrierstoinvestinginRwandaSource:MilkenInstituteCenterforFinancialMarketssurveyofEACinstitutionalinvestors

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0% 30% 60% 90%

Investorrights,generally

Minorityshareholderrights

Accesstothecourts

Disclosurestandards

Willingnesstoengagewithinvestors

Oversightcapacityofcorporateboards

Responsivenessofregulators

Lowcorrupvon

%ofrespondents

Top-performing Second-best Third-best

0% 30% 60%

Corrupvon

Responsivenessofregulators

Accesstothecourts

Oversightcapacityofcorporateboards

Investorrights,generally

Minorityshareholderrights

Disclosurestandards

Willingnessofbusinessestoengagewithinvestors

%ofrespondents

Needsmostimprovement Second-worst Third-worst

FIGURE 12. How EAC institutional investors view Rwanda’s corporate governance and legal environment

Best-performing

Needsmostimprovement

Source:MilkenInstituteCenterforFinancialMarketssurveyofEACinstitutionalinvestorsNote:SurveyparticipantsinKenya,Tanzania,andUgandawereaskedtoselectthethreebest-performingaspectsofRwanda’scorporategovernanceandlegalenvironment,aswellasthethreeaspectsthatneededthemostimprovement.Thechartsaboveaggregatetheirresponses.

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C.InvestorappetiteforincreasinginvestmentsinRwanda

TobetterunderstandwhattypesofinvestmentsmightdrawregionalcapitaltoRwanda,oursurveyaskedinvestorstoindicatetheirinterestinincreasinginvestmentsinparticularassetclassesoverthenexttwoyears.TheseassetsincludedthreetypesofsecuritiescurrentlyavailableontheRwandanmarkets:governmentbonds,corporatebonds,andlistedequities.AsoneEACcountryregulatortoldtheMilkenInstitute,however,“Pensionfundsaregrowing,buttheyareoutpacingtheamountofinvestableproductonthemarket.”Sincethesmallsupplyofinvestmentvehiclesisawidelyacknowledgedchallengetocapital-marketdevelopment,thesurveyalsoaskedparticipatinginstitutionalinvestorsabouttheirpotentialinterestinnineassetcategoriesthatarenotcurrentlyavailableonRwanda’smarketsbutcouldbeinthefuture.

Consideringthecurrentlyavailablecapital-marketsecurities,65percentofEACinstitutionalinvestorsareinterestedinincreasingtheirinvestmentsinlistedsharesontheRwandaStockExchangeoverthenexttwoyears.AsshowninFigure13,asimilarproportionofjustover60percentofnon-RwandanEACrespondentssaytheywouldlooktoincreaseinvestmentsinRwandangovernmentbondsoverthenextfewyears.Ontheotherhand,thereislittleappetiteforRwandancorporatebonds,with55percentofEACinvestorsindicatingnointerestinincreasinginvestmentsinthisassetclassinthenextfewyears.However,thislackofinterestinRwandancorporatebondslikelyreflectsthefactthatthereisonlyonesuchsecuritycurrentlylistedandthemarketisthushighlyilliquid.Evenassumingmorefirmsissuebondsoverthenextfewyears,therealsocouldbeamoregeneraldisinterestinthisassetclassamongEACinstitutionalinvestors.Asdiscussedabove,lessthanhalfofsurveyedinvestorsholdcorporatebondsatall,andthosethatdogenerallyallocatearelativelysmallpercentageoftheirportfoliostothisassetclass.

50

0% 20% 40% 60% 80% 100%

ViewsofRwandaninstitutionalinvestors

0% 20% 40% 60% 80% 100%

Rwandangovernmentbonds

Rwandancorporatebonds

EquitieslistedontheRSE

Rwandangovernmentbonds

Rwandancorporatebonds

EquitieslistedontheRSE

FIGURE 13. Interest in increasing investment in currently avai lable securit ies l isted on Rwandan capital markets

Source:MilkenInstituteCenterforFinancialMarketssurveyofEACinstitutionalinvestorsNotably,somesurveyednon-RwandanEACinstitutionalinvestorsindicatedtheywouldliketoincreasetheirinvestmentsinRwandansecurities,buttheybelievetheywouldberestrictedfromdoingsoevenincaseswhereitwouldbepermitted.Thisconcernexistsamong27percentoffirmswithregardtoinvestmentsontheRSE,17percentoffirmsconsideringincreasinginvestmentsingovernmentbonds,and32percentoffirmswhenitcomestoRwandancorporatebonds.Inallbutafewofthesecases,thefirmsthatareinterestedinincreasingtheirinvestmentsbutbelieveitwouldnotbepermittedarebasedinUganda.AndtheytendtobeUgandanpension-sectorrespondentsmoreoftenthaninsurancefirms.Fromaregulatoryperspective,Ugandanpensionfunds’investmentsintheseRwandansecuritiesaretreatedasdomestic—subjecttothesamerulesasinvestmentinthesesecuritieslistedonUganda’sdomesticmarket,asdiscussedabove.SeveralUgandanpensionschemes,therefore,appeartobeoperatingwithamisunderstandingoftheintraregionalregulatoryrestrictionsbyassetclassthattheyactuallyface—ortheymaybeimpededmorebyinternalrestrictionssetbytheirownboardmembers.

Ontheotherhand,Ugandaninsuranceregulatorsdonotpermitintra-EACinvestmentsatall.Somewhatsurprisingly,atleastoneRwandaninsurancecompanyalsoperceivedrestrictionsoninvestingingovernmentandcorporatebondstobemorerestrictivethantheyactuallyare.ThisindicatesaneedforbothUgandanandRwandanregulatorstocommunicateclearlytoinstitutionalinvestorsintheircountrieshowcurrentregulationsactuallyaffecttheirabilitytoallocateassetsacrossclassesandintraregionally.

ViewsofKenyan,Tanzanian,andUgandaninstitutionalinvestors

Yes,interestedandwillinvest Interested,butnotallowed No,notinterested

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Amongpossibleinvestmentvehiclesthatcouldbedevelopedinthefuture,surveyedEACinvestorshavethemostappetiteforanEACinfrastructure“fundoffunds,”followedbyinterestinRwandangovernmentdebtissuedinKenyanshillingsandRwandaninfrastructurebonds.Morespecifically,75percentofparticipatingKenyan,Tanzanian,andUgandaninvestorswouldbewillingtoinvestinaregionalinfrastructure“fundoffunds”thatwouldincludeprojectsinRwanda.86Nearly70percentofnon-RwandanrespondentsareinterestedininvestingdirectlyinRwandaninfrastructureprojectsfinancedwithbonds.And72percentwouldbeinterestedininvestinginRwandantreasurybondsdenominatedinKenyanshillingsifthesesecuritiesweretobecomeavailable.Over60percentofinvestorsexpressinterestinprivateequityinvestmentsinRwandaoraprivateequityregionalfundfortheEAC.

Ontheotherendofthecontinuum,REITslistedontheRSE,exchange-tradedfunds(ETFs),andglobaldepositoryreceiptsareofcomparativelylessinterestaspotentialinvestableinstrumentstoEACinstitutionalinvestors.InvestorsshowtheleastappetiteforunlistedREITsavailableonRwanda’smarket,with77percentofnon-RwandanEACrespondentssayingtheywouldnotinvestinthisproductifitwasavailable.TheseresultsareperhapstobeexpectedasmanyoftheseproductsarenotyetavailableeveninKenya,andinvestorsmaynotbefamiliarwiththemandmayviewtheirintroductionasprematuregiventheunderdeveloped,nascentstateofRwanda’smarket.InAugust2015,theCapitalMarketsAuthorityofKenyaissuedguidanceontheintroductionofETFs,buttodatenonehavebeenestablished.CMA-Kenyaonlyrecently(inOctober2016)requestedstakeholderfeedbackontheregulatoryframeworkfortheintroductionofglobaldepositoryreceiptsandnotestotheKenyanmarkets.ListedREITs,however,havebeentradedontheNairobiSecuritiesExchangesinceOctober2015,whenitbecameonlythefourthexchangeinAfricatoofferthisproducttoinvestors.87AccordingtooneEACpensionfundmanagerwhoparticipatedinoursurvey,REITslistedonanexchangemaybeonewaytomanageriskassociatedwithinvestmentinrealestate,byreducingdirectexposuretothemarket.

86Aregional“fundoffunds”wouldpoolresourcesandcouldbestructuredtoinvestinadiverseportfolioofinfrastructureproductsacrosstheregion,includingtheNorthernCorridortransportroute.This“fundoffunds”couldpoolriskbydiversifyingitsportfolioacrossanumberofdifferentprojectsbysectorandcountry.Rwandaninvestorsalsoshowenthusiasmforthisproduct,withallparticipatingRwandanfirmsindicatingtheywouldbeinterestedininvestingininfrastructurebondsissuedinRwanda.87DailyNation,“HistoryasStanlibLaunchesKenya’sfirstREITIPO”(October22,2015).

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ViewsofKenyan,Tanzanian,andUgandaninstitutionalinvestors

0% 20% 40% 60% 80% 100%

ViewsofRwandaninstitutionalinvestors

FIGURE 14. Gauging investors’ interest in possible future products on Rwanda’s markets

Source:MilkenInstituteCenterforFinancialMarketssurveyofEACinstitutionalinvestorsNote:SurveyparticipantswereaskedtoassesstheirlevelofpotentialinterestinassetclassesnotcurrentlyavailableinRwanda’sfinancialmarkets,assumingtheseweretobecomeavailableinthefuture.Thechartsaboveaggregatetheirresponses.Kenyanpensionfundsandassetmanagers,perhapsunsurprisingly,showstrongenthusiasmforanyfuturepossibleopportunitytoinvestinRwandangovernmentbondsdenominatedinKenyanshillings,with77percentexpressinginterestinthistypeofissuance.FromtheRwandangovernmentperspective,suchanissuancewouldenablethecountrytopotentiallytapalargepoolofinvestors,particularlythemorethan$11billionincontractualsavingsavailableinKenya.ForKenyaninvestors,thebenefitsoftakingupsuchanissuewouldbetheabilitytodiversifytheirportfoliosintoRwandawithoutthecommensurateforeignexchangerisk.Ugandanfirms,notably,findaKenyan-shilling-denominatedbondasattractiveastheirKenyancounterpartsdo,with78percentofsurveyedUgandanfirmsindicatingawillingnesstoinvestinsuchbondsiftheybecomeavailable.Asshownabove,severalUgandanfirmshaveincreasedtheirinvestmentinKenyanassetstotakeadvantageofexchange-ratetrends.Andtheattractionofthispossiblesecurityisnotlimitedtoforeigninvestors.Asmanyas86percentofRwandaninstitutionalinvestorswouldalsowanttoinvestinRwandantreasurybondsdenominatedinKenyanshillings.

Astrongmajorityofparticipatingnon-RwandanEACinstitutionalinvestorsalsoshowinterestinincreasinginvestmentinprivateequityinRwanda.Abouttwo-thirdsofinvestorsinotherEACcountrieswouldliketoinvestineitheranEAC-wideprivateequityfundorinprivateequityorventurecapitalinvestmentsinRwanda,iftheseinvestmentvehiclesbecomeavailable.However,firmsexpressedconcernabouthowregulations(astheycurrentlyexist)wouldaffecttheirpotentialabilitytotakeup

0% 20% 40% 60% 80% 100%

EACinfrastructurefundoffunds

Rwandangovt.bondsdenominatedinKES

InfrastructurebondsissuedinRwanda

PrivateequityregionalfundoffundsfortheEAC

PrivateequityandventurecapitalinRwanda

Globaldepositoryreceipts/notes

REITslistedontheRwandaStockExchange

Exchange-tradedfunds(ETFs)

UnlistedREITs

EACinfrastructurefundoffunds

Rwandangovt.bondsdenominatedinKES

InfrastructurebondsissuedinRwanda

PrivateequityregionalfundoffundsfortheEAC

PrivateequityandventurecapitalinRwanda Globaldepositoryreceipts/notes

REITslistedontheRwandaStockExchange

Exchange-tradedfunds(ETFs)

UnlistedREITs

Yes,interestedandwillinvest Interested,butnotallowed No,notinterested

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theseassets.Inthiscase,theirworriesarenotwithoutcause.InvestmentsbyKenyanpensionfundmanagersinprivateequitydealsoutsideKenyaaresubjecttothesamerestrictionsasthosethatapplytoinvestmentsinnon-EACcountries.Incontrast,forUgandanpensionfundmanagers,investmentsinprivateequityinotherEACcountrieswouldbeconsidereddomestic.Tanzanianpensionregulationsdonotyetspecifyanylimitsonnon-domesticprivateequityinvestments.

VII.ConclusionsandpolicyimplicationsItisbroadlyacknowledgedthatlocalinstitutionalinvestorscanplayanimportantroleincapital-marketdevelopment.Thislong-termmoneycanhelpcatalyzeinvestmentfromothersourcestodeepencapitalmarkets.Oursurveysoughttounderstandhowlocalinstitutionalinvestorsallocatetheirassetsandwhatmightpreventthemfromfurtherdiversifyingtheirportfolios.Tothedegreethatinvestorscurrentlyarenotdiversifyingacrossassetclassesorgeographically,wesoughttounderstandwhetherthiswasduetoregulatorybarriers,capacityissues,and-orotherfactors.

Overall,thelocalinstitutionalinvestorbaseisdeepeningacrosstheEAC.National-levelstatisticsshowthatpensionfundsandinsurancecompaniesacrossthesubregionhavenearlydoubledtheirportfolioassetsinrecentyears,from$10.7billionin2011toabout$19.1billionin2015.88Whileonlyasmallpercentageofthetotalpopulationsofthesecountrieshaveaccesstopensionandinsuranceproducts,theseindustriesaregrowing,andtheselocalinvestorswillalmostcertainlyplayasignificantroleinhowtheEAC’scapitalmarketsdevelopinthecomingyears.Surveyfindingsindicatethattheseinvestorsgenerallyaretakingamorediversifiedportfolioapproachanddesiretofurtherdiversifytheirportfolios.

OursurveyfindingsalsoindicatethatmanyinstitutionalinvestorsintheEACcontinuetoholdasignificantshareoftheirassetsingovernmentsecurities,however,aswellasrealestateandbankdeposits,whileinvestingverylittleincorporatesecurities.PreferentialregulatorytreatmentmaybeinducingatleastsomeinstitutionalinvestorsintheEACtooverallocatetogovernmentsecuritiesattheexpenseofotherassetclasses.AsChan-Lau(2004)observedmorethanadecadeagoinseveralAsianandLatinAmericanmarkets,thelimitedsupplyofinvestablesecuritiesinunderdeveloped,still-emerginglocalcapitalmarketscanconstraintheabilityofinstitutionalinvestorstotakeamorediversifiedportfolioapproach.

Relativelyheavyallocationstogovernmentsecuritiesmayalsopartlyreflecthighlevelsofcapacityforassessinggovernmentsecuritiescomparedwithother,newerinvestmentvehicles.Reportedlevelsofcapacitytrackcloselywithhowfirmsallocatetheirassets,suggestingthatfurtherportfoliodiversificationnaturallyalsomaybelinkedtocapacitydevelopment.Oursurveyfindingsindicatethatabout95percentofsurveyedinvestorsratedtheirowncapacitytoassessgovernmentsecuritiesasgoodtoexcellent,whileonly29percentreportgoodorexcellentcapacitytoassessprivateequity,and14percentreportpoororverypoorcapacity.

Verysmallallocationstoprivateequity,venturecapital,andunlistedequitiesbyinstitutionalinvestorsintheEACpartlyreflectcapacitylimitationsandlackofexperienceinassessingthisassetclass,rather

88Nationalregulatorandauthorcalculations.

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thanlackofdemandorconstrainingregulatoryinvestmentlimits.Infact,inthecaseofPE/VCinparticular,regulatoryapproachesandinvestorresponsesarestillevolving.KenyaandUgandahaveestablishedspecificregulatorylimitsontheshareofpensionfundportfoliosallocatedtoprivateequityandventurecapital.Noneofthefourfocuscountrieshavespecificallyaddressedhowtheywillregulateinsurers’assetallocationstoPE/VC.

Greaterclarityonhowprivateequityandotherrelativelynew,alternativeinvestmentinstrumentsaretreatedbynationalregulatorsasinvestableassetclassesmayenableandencouragelocalinstitutionalinvestorstofurtherdiversifytheirportfolios.Thesealternativeinvestmentinstrumentscertainlyarenotrisk-freeandremainaverysmallpartofinstitutionalinvestorportfoliosworldwide,includingincountrieswithdeepandliquidfinancialmarkets.Butsomediversificationintothisassetclassinthecontextofawell-managedportfoliocouldhelpgeneratereturns.Asdemandfortheseinvestmentvehiclesgrows,itwillbeimportanttoboostrisk-evaluationcapacityamongregulators,investors,andfinancialintermediaries.

Moreover,continuedstronggrowthofassetsmanagedbyinstitutionalinvestorsintheEACwithoutcommensuratedevelopmentofinvestmentalternativesraisesinvestors’riskofbeingoverlyconcentratedinjustafewassets.This,inturn,canimpedetheirabilitytoadequatelymanagerisk.

Regulationsthatsteerinvestorsintoinvestmentdecisionsthatplaceexcessemphasisonuniformportfolioperformancewithoutregardtogeneratingreturnscanimpedethepotentialforemerginginstitutionalinvestorstoallocateassetstomoreproductiveinvestments,includingthosethatcouldspursocioeconomicdevelopment.Wheninstitutionalinvestorshavetheroomtomaneuvertotakeamorediversifiedportfolioapproachthatseekstomaximizereturnsandinvestinproductiveeconomicsectors,whilestillsafeguardingthepublic’ssavings,morepeoplemayalsobeincentivizedtoplacemoneywithcontractualsavingsproducts.89Ourfindingsshowthat,inmostcases,regulatoryinvestmentlimitsarenotthebindingconstraintpreventinglocalinstitutionalinvestorsintheEACfromdiversifyingtheirportfolios.Firms’allocationstopublicequitiesandcorporatebondsgenerallyfallfarbelownationalregulatorycaps.ThevastmajorityofsurveyedfirmsinKenya,Tanzania,andUgandaalsosettheirowninternaltargetthresholdsforinvestmentsingovernmentsecurities.Theseinternalceilings,particularlyforshort-termgovernmentsecurities,tendtofallwellbelowthenationalceilings—asdothesefirms’actualinvestmentsinthesesecurities.Whilenationallyimposedandinvestors’owninternalceilingsdonotappeartobeanimpediment,itwillbeimportantforpolicymakerstoremainmindfulabouthowinvestmentlimitssetfordifferentassetclassesinfluencehowinvestorsmanagetheirportfolios.90

ThereisanoverallneedintheEACfocuscountriesformore“product”—morelonger-terminvestmentinstrumentsinparticular—andalsomoremarketparticipants.Forexample,withsecondarymarketsforcorporatebondsalmostnonexistent,investorsnowoftenholdthesesecuritiestomaturity.Andmoreneedstobedonetoraiseawarenessofhowlistingoncapitalmarketscanbenefitfirms—toaddressthe

89SeeInderst,GeorgandFionaStewart,“InstitutionalInvestmentinInfrastructureinEmergingMarketsandDevelopingEconomies”(2014)(Washington,DC:WorldBank).90SeeChan-Lau,Jorge,“PensionFundsandEmergingMarkets”(2004),IMFworkingpaper(Washington:IMF)andStewart,F.andJ.Yermo,“PensionsinAfrica”(2009),OECDWorkingPapersonInsuranceandPrivatePensions,No.30(Paris:OECD).

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disconnectinknowledgeandperceptionsthatcontributetotheilliquidityandsmallsizeoflocalcapitalmarkets.

Therealsoisalackofappropriatelydesignedandstructuredproductsthatallowinstitutionalinvestorstoinvestinawaythatmeetstheirownaims.Thislatterissuecanbeaproblemevenindevelopedeconomies,however.91Sincethesmallsupplyofinvestmentvehiclesisawidelyacknowledgedcorechallengetocapital-marketdevelopment,particularlyinasmallfinancialmarketsuchasRwanda’s,thesurveyaskedparticipatinginstitutionalinvestorsabouttheirpotentialinterestinseveralassetcategoriesthatarenotcurrentlyavailableinRwandabutcouldbeinthefuture.Amongpossibleinvestmentvehiclesthatcouldbedeveloped,surveyedEACinvestorshavethemostappetiteforanEACinfrastructure“fundoffunds.”Asmanyas75percentofparticipatingKenyan,Tanzanian,andUgandaninvestorswouldbewillingtoinvestinaregionalinfrastructure“fundoffunds”thatwouldincludeprojectsinRwanda.

Amajorityofnon-RwandanrespondentsalsowouldbeinterestedininvestingdirectlyinRwandaninfrastructureprojectsfinancedwithbonds,aswellasinRwandangovernmentdebtdenominatedinKenyanshillings,iftheseinvestmentvehiclesweretobecomeavailable.AndamajorityofsurveyedinvestorsexpressstronginterestinprivateequityinvestmentsinRwandaoraprivateequityregionalfundfortheEAC.

Anintraregional“fundoffunds”thatinvestsspecificallyinPE/VCcouldhelpmitigatesomeoftheriskinvestorsfaceinbeingoverconcentratedinjustafewassetsandfacilitatetheabilityofinvestorstodiversifyintothisnewassetclass.92Underonepossiblemodel,EACinstitutionalinvestorscouldthemselvesseedsucharegionalfundtofocusoninvestinginSMEsacrosstheregion.Underanothermodel,governmentanddonorscouldencouragedevelopmentofthesefundsbyofferingtechnicalassistancetoimproveSMEfinancialreporting,helpentrepreneursdevelopbusinessplans,andhelpfundmanagersidentifyinvestmenttargets.MakingavailablealistofregisteredSMEstopotentialVC/PEinvestorsisonerelativelyeasystepthatwouldfacilitatedevelopmentofthesefunds.

FurtherprogressonintraregionalintegrationwithintheEACmayhelptomitigatesomeoftherisksassociatedwithcross-borderinvestment.ThelimitedsupplyofinvestablesecuritiesinlocalcapitalmarketsstrengthensthecaseforeasingorharmonizingrestrictionswithintheEACsoinvestorswithsignificantassetscanlooktodiversifytheirportfoliosacrossEACcountriesaswellasassetclasses.Sincepensionfundsandinsurancecompanieshaveaspartoftheirmandatesthesafeguardingofreturnsforpensionersandshareholders,itisimportantthattheyalsobeabletodiversifyriskthroughinvestmentsabroad,particularlywithintheEACsubregion.ThisregionalapproachalsowouldhelpdeveloptheverysmallinstitutionalinvestorbasesincountriessuchasRwanda.Morecross-borderlistingsaswellascross-borderinvestmentintheEACcouldhelpovercomenationalcapitalmarkets’impedimentsofsmallsize,illiquidity,andinadequatemarketinfrastructure.Andthisintraregionalapproachtocapital-market

91SeeInderst,GeorgandFionaStewart,“InstitutionalInvestmentinInfrastructureinEmergingMarketsandDevelopingEconomies”(2014)(Washington,DC:WorldBank).92See,e.g.,Ashiagbor,Davidetal.,“PensionFundsandPrivateEquity:UnlockingAfrica’sPotential”(2014)(London:CommonwealthSecretariat).Seealso,Irving,Schellhase,andWoodsome,“FramingtheIssues:DevelopingCapitalMarketsinRwanda”(2016)(Washington,DC:MilkenInstitute).

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developmentcouldfacilitatetheabilityoffirmsandgovernmentsinthesecountriestoraisefinancingforinfrastructureandothersocioeconomicdevelopment.Halfofallsurveyedinstitutionalinvestorsallocatesomeportionoftheirportfoliotoassetsoutsidetheirhomecountries.Topmotivesareopportunitytomanagecountryand-orforeignexchangeriskandopportunitiesfordiversificationandenhancedreturns.AssetsdomiciledinKenyaattractthevastmajorityofforeigninvestmentfromfirmsinotherEACcountries,particularlyUganda.Ofcourse,diversifyingassetsacrosscountriescarriesitsownrisks,whichneedtobemanagedappropriately.

Theoretically,atleast,investmentsinassetsdomiciledinotherEACmemberstateswouldbeconsidereddomesticinvestmentsunderthe2010EACCommonMarketProtocol.Inpractice,regulatorshaveflaggedsomeassetclasseswhereotherEACcountriesasplaceofdomicileareconsideredforeignwhileothersareconsidereddomestic.Atthesametime,roughlyhalfofinstitutionalinvestorsintheEAChaveinternalguidelinesthattreatinvestmentsinotherEACcountriesasforeign.Yetsurveyedfirmstendtofallwellshortofceilingssetbytheirownfirms’internalguidelinesinholdingassetsinnon-localEACcountries—includingforkeyassetcategoriesthatcouldhelpdiversifytheirportfolios.

Surveyfindingsindicatethatsomeinstitutionalinvestorsareoperatingwithamisunderstandingoftheactualintraregionalregulatoryrestrictionsbyassetclassthattheyactuallyface—ortheymaybeimpededmorebyinternalrestrictionssetbytheirownboardmembersthanbynationalregulatorylimits.RegulatorsshouldstepuptheircommunicationseffortswithinstitutionalinvestorstoensurethattheyclearlyunderstandboththelimitsandopportunitiesinhowtheyinvestacrossassetclassesandwithintheEAC.

Alackofhedginginstrumentsandstrategiesformanagingforeigncurrencyriskalsoseemstoimpedetheabilityofinstitutionalinvestorstotakeamorediversifiedportfolioapproachintraregionally.AlargemajorityofsurveyedinstitutionalinvestorsacrosstheEACreporttheylackadequatetoolsandstrategiesformanagingforeignexchangerisk.NearlyhalfwouldinvestmoreacrosstheEACiftheyhadaccesstothesetools.

AlargemajorityofpensionfundsacrosstheEACuseexternalmanagers.Institutionalinvestorsoftenlooktoexternalmanagerstoattaintangiblebenefitsfromskilltransfersandtogaina“guidedbenchmark.”Onepossiblewaytoaddressoneofthechallengesposedbysmallfinancialmarketswouldbeforinstitutionalinvestorstolooktoworkwithexternalfundmanagersthatareintraregionalintheirinvestmentstrategy.

FurtherbuildingcapacityamongbothinstitutionalinvestorsandregulatorsintheEAC,particularlyforevaluatingnewerassetcategoriessuchasPE/VC,willbeimportantinenhancingtheabilityofinvestorstomanagerisksaswellasidentifyprofit-generatingopportunities.AsnationalpensionandinsurancesectorsgrowandtheirproductsaretakenupbymorepeopleacrosstheEAC,itwillbecomeimperativetoimprovethecapacityofregulatorsandassetmanagerstoevaluatethesenewassetcategories.Oursurveyfindingsalsounderscorethatitwillbeimportanttobuildcapacityamonginstitutionalinvestorsformanagingprice-volatilityandforeignexchangerisks.

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ItwillbeimportantforEACcountriestobuildontheirprogressinimplementingreformsthatdevelopcapitalmarkets,includingthosethatencourageprivatelymanagedpensionfundsandotherinstitutionalinvestorswithlong-terminvestmenthorizons.Thiswillbeakeysteptowardimprovingfinancialintermediationinthesemarketsandincreasingfinancialmarketcompetitivenessoverall.Itwillalsopavethewayforinvestorswithlonger-termhorizonstoserveasawell-neededsourceoffinancingforinfrastructure.Applyingthesameprinciplesandstandardsinmanaging,supervising,andincentivizingpublic-sectorpensionschemesasapplytoprivatelyrunschemeswillhelpinculcateanapproachtomanaginginvestmentportfoliosthatemphasizesmaximizingreturnswhilemanagingrisk.93

93SeealsoCallundConsulting,“ReviewoftheStructureofthePensionSectorintheEAC”(2013)(London:CallundConsulting);EconomicPolicyResearchCenter,“UgandaFinscopeIII:SurveyReportFindings”(2013)(Kampala:EconomicPolicyResearchCenter).

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Addendum:Highlightsfromaroundtablediscussionondevelopingcapitalmarkets,2016MilkenInstituteLondonSummitOnDecember6,2016,theMilkenInstitute’sCenterforFinancialMarkets(CFM)hostedaroundtable,“TheRoleoftheBuySideinDevelopingCapitalMarkets,”aspartoftheMilkenInstituteLondonSummit.Roundtableparticipantsincludedinstitutionalinvestorsfromemergingandadvancedeconomies,financialfirmsworkinginEastAfrica,anddevelopmenteconomists.Asaspringboardfordiscussion,CFMpresentedevidence-basedresearchfindingsfromitssurveyondevelopingthebuysideinEastAfrica.Adiscussionfollowedontheroleoflocalinstitutionalinvestorsincapital-marketdevelopmentmorebroadly.Thediscussionalsotouchedonissuesthatwerebeyondthescopeofthemainthemesinthispaper,someofwhichcouldbetopicsforfurtherresearchandotherwork.

Asoneparticipantnotedearlyinthediscussion,diversifyinganddeepeningtheinvestorbaseisonecriticalcomponentindevelopinglocalcapitalmarketsthateffectivelyintermediatelong-termfinance.Andyet,asthisparticipantobserved,localinstitutionalinvestorsoftenbuyandhold,somarketscanremainilliquidevenasassetsundermanagementincrease.Otherimportantfactorsinamultiprongedapproachtocapital-marketdevelopmentareincreasinginvestableproductandensuringanappropriate,enablingenvironment.Adiverseinvestorbasethatincludesinvestorswitharangeofriskpreferencesandtimehorizonsisalsoimportant.Inadditiontodevelopingpensionfundsandinsurancecompanies,thisrequiresaproperlysequencedapproachtobringinginmutualfunds(unittrusts),retail,andothertypesofinvestors,underpinnedbyanappropriateandsoundsupervisoryframework.Atthesametime,asanotherparticipantemphasized,capital-marketdevelopmentmustbeapproachedwithinthebroaderframeworkoffinancial-sectordevelopment.

Severalparticipantsarguedthatsomeeconomiesaretoosmalltosustaindeep,liquidcapitalmarkets.Somequestionedwhethersmalleconomiesshouldfocusondevelopingtheirowncapitalmarkets.Low-incomecountriessometimesinvestsignificant(scarce)resources,forexample,onthemarketinfrastructureneededforanationalstockexchange,viewingitasanationalflagship.Asacounterpoint,someparticipantsarguedthatlocalcapitalmarketsareimportanttofinancial-andprivate-sectordevelopmentbecause,forexample,evenlargelocalfirmsmaylackaccesstobankandothersourcesoffinance.Sincesmallandmedium-sizedenterprisestypicallyarethebackboneofemergingandfrontiermarketeconomies,thishighlightsarelatedquestionofwhetherandhowSMEsshouldaccesscapitalmarkets.Thisissuehasonlyrecentlybeguntoreceiveattentionintheempiricalliterature,mostlyonaselectivecountrybasis,andfurtherstudyisneeded.

Oneparticipantpointedouttheneedforlocal-currencyfinancingasareasontodeveloplocalcapitalmarkets.Thisisespeciallyimportantforcompaniesthatsellprimarilytodomesticmarketsandforfinancinginfrastructureprojectsthatearnrevenuesinlocalcurrency.Securitiesissuedoninternationalcapitalmarketscanhavehighcountry-riskpremiumsandcarrytheriskofcurrencymismatch.

Regionalcooperationandintegrationoffinancialmarketsmayprovideonewaytoovercomesizebarrierswhileensuringthatlocalcompanieshaveaccesstothefinancingtheyneed.Asoneparticipantsaid,developingcountriesmuststriketherightbalanceinbuildingalocalandintraregionalinstitutional

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baseandattractinginvestorsfromoutsidetheregion.AnotherparticipantnotedthatmanyEuropeancountrieswerealsoconstrainedbythesizeoftheirdomesticmarketspriortoEuropeanintegration.Hefurtherarguedthateventhesehighlydevelopedfinancialmarketsmayofferselectivelessonstoemergingandfrontiermarketsseekingtotakearegionalapproachtodevelopingtheircapitalmarkets.

Thewaysinwhichdomesticandforeigninvestorsinteract—andhowtheybestcomplementeachother—couldalsobeafruitfultopicforfutureresearch.Institutionalinvestorsattheroundtableemphasizedtheimportanceofparticipatinginandpromotingfundsthatinvestindevelopingcountries.Oneparticipantobservedthatfinancialinstitutionsinhigh-incomecountriesmaybeabletoplayaroleindevelopingfinancialproductsthatarewell-suitedforfrontiermarkets.HecitedasanexampleaninvestmentbankthathadsteppedintohelpAfricantelecomcompaniesissuelocalbonds.Itcouldbeusefultofurtherexaminewhatnewfinancialproductscouldattracttheinterestoflocalinstitutionalinvestors,suchasthe“fundoffunds”modelforprivateequityorinfrastructureinvestments.Roundtableparticipantsalsopointedtotheopportunityforinternationalinstitutionalinvestorstoengagewithtechnicalcapacityandknowledgeexchangeprogramsthatseektostrengthenlocalinstitutionsinfrontiermarketsthroughinvestmentsinhumancapital.Futureevidence-basedresearchcouldusefullyexaminewhethersuchprogramsmeettheiraimsand,ifso,underwhatcircumstances.

Severalparticipantsemphasizedtheimportanceofintermediariesindevelopingfinancialproducts.Aparticipantwithaninvestmentbankactiveinemergingandfrontiermarketsremarkedthattoolittleattentionwasgiventotheroleofintermediariesincapital-marketdevelopment,arguingthatintermediarieswereamorecommonsourceofinnovationthaninvestorsorthegovernment.Thepotentialimpactofintermediariesoncapital-marketdevelopmentinfrontiermarketsiscertainlyatopicthatmeritsfurtherresearchaswellasconsiderationfromsecuritiesregulators.

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AbouttheAuthorsJacquelineIrvingisadirectorwiththeCenterforFinancialMarketsattheMilkenInstitute,wheresheleadspolicyresearchandotherinstituteinitiativesonstrengtheningcapitalmarketsindevelopingcountries.Formoreinformationregardingthispaperorthecenter’sworkintheCapitalMarketsforDevelopmentprogram,contactJacquelineatjirving@milkeninstitute.org.JohnSchellhaseisanassociatedirectorattheCenterforFinancialMarketsattheMilkenInstitute.Hisworkprimarilyfocusesonfinancial-marketdevelopmentindevelopingcountries.

JimWoodsomeisaseniorresearchanalystwiththeCenterforFinancialMarketsattheMilkenInstitute,whereheconductsresearchandhelpsmanageinitiativesrelatedtothecenter’sCapitalMarketsforDevelopmentprogram.

AbouttheMilkenInstituteTheMilkenInstituteisanonprofit,nonpartisanthinktankdeterminedtoincreaseglobalprosperitybyadvancingcollaborativesolutionsthatwidenaccesstocapital,createjobs,andimprovehealth.Wedothisthroughindependent,data-drivenresearch,action-orientedmeetings,andmeaningfulpolicyinitiatives.

AbouttheCenterforFinancialMarketsBasedinWashington,D.C.,theCenterforFinancialMarketspromotesfinancial-marketunderstandingandworkstoexpandaccesstocapital,strengthen—anddeepen—financialmarkets,anddevelopinnovativefinancialsolutionstothemostpressingglobalchallenges.TheCenter’sCapitalMarketsforDevelopmentprogramexplorespracticalpolicysolutionstostrengthenanddeependeveloping-countrycapitalmarketsandencourageproductiveinvestment. ©2017MilkenInstituteThisworkismadeavailableunderthetermsoftheCreativeCommonsAttribution-NonCommercial-NoDerivs3.0UnportedLicense,availableatcreativecommons.org/licenses/by-nc-nd/3.0/