Debunking Myths about Private Offers

22 July, 2024 / Articles

In Kenya, the capital markets can be divided into two large categories - regulated and unregulated markets. Regulated markets are overseen by a regulator, the Capital Markets Authority. Products in this market tend to be standardized and easily accessible to the public. Unregulated markets on the other hand, are governed by the prevailing contracts between the participating parties and therefore they are not regulated by a specific regulator; however, the process of offering is usually regulated so that it follows a set of defined rules and guidelines. The manner of offering is usually private; hence, they are also loosely referred to as private products or private offers. Since they are an alternative to public markets products, they are also referred to as alternative market products. Examples of unregulated products in the Kenyan Market include Real Estate, Private Equity, Structured products and Commercial papers.

There have been many myths about unregulated products, often due to the general public not understanding the products well enough. Below we explore and debunk some of the myths:

  1. Private offers are risky investments: Unregulated products are not necessarily riskier investment options, especially when they are sourced through a competent research and investment team, and one that has experience in managing illiquid and alternative assets. Take Real Estate for example, where the project has been sourced through detailed research and is delivered by a well-run and professional project manager, and there is visibility over pre-sales. Such an investment would be attractive for those seeking diversification in their portfolios,
  2. Private offers are too complex: Unregulated investments are really not more complex than regulated products, in spite of the jargon that usually accompanies them. Unregulated products operate in a similar way to regulated products in that they collect funds from clients, invest in various markets with the aim of delivering a return. When packaged well, any investor is able to understand and invest in an unregulated product as easily as they would in a regulated product,
  3. They cannot be offered by regulated entities: Regulated entities can offer both regulated and unregulated products. For any regulated product, it is approved by the respective regulator, similarly, any unregulated product also needs to pass through the respective regulator,
  4. They are unlawful: Unregulated products are often viewed as unlawful and regarded with a lot of suspicion, mainly because they do not require regulatory approval. However, it is important for investors to note that even without regulatory approval, the unregulated products are still issued within the confines of set guidelines by the regulators,
  5. They can only be distributed to a few individuals: There is a myth that unregulated private products must only be distributed to a few individuals. There are ample case laws to demonstrate that what matters is the manner of offering, and not the number of investors. Courts have concluded that an offer even to one person is deemed a public offer if it was offered in a public manner, and an offer even to a million people is a private offer if it was offered in a private manner, and,
  6. Regulated parties do not invest in alternatives: Regulated funds and products usually all have an allocation to alternative investments. The simplest example is that any deposit in a bank is then pushed forward by a bank and lent to an individual for a mortgage, or a developer to undertake a development project. Unit Trust Funds in Kenya as well, as per the regulations, are allowed to invest in alternative investments such as Real Estate and Private Equity.

It is important for any investor to fully understand the product they invest in and as such, we believe that each investor should seek financial advice before investing. This way, one is able to make investment decisions based on facts as opposed to myths. Further, there are numerous benefits of investing in private offers, including:

  1. Relatively Higher Returns – Structured products combine the higher liquidity offered by traditional investments such as publicly listed equities, and, relatively higher returns offered by alternative investments such as Real Estate. The higher returns, in comparison to traditional investments, also help investors protect their investments against inflationary pressures,
  2. Low Correlation of Returns – Structured products have their own value that is not dependent on factors that affect traditional investments, and are thus able to provide a real return to investors. For instance, if the public equities markets suffer from lower returns because of higher taxes on dividend payouts or dwindling investors’ interest occasioned by volatility, a structured product such as a Real Estate loan note will remain unaffected, and,
  3. Diversification – Diversification helps an investor to reduce the overall risk attached to their portfolio by spreading the risks over the different types of investments. As a result of the low correlation with traditional investments, structured products do not move in tandem with the publicly listed markets, a factor that enhances diversification benefits.

Private offers are also beneficial to issuers as they enable them to raise the much needed capital to fund their businesses. For economies to grow, there is a need for companies to be in a position to access capital to finance their businesses. According to World Bank data, in more developed markets, both regulated and unregulated capital markets contribute about 600% of all business funding with the remaining 40.0% of funding coming from banks. Currently, approximately 99.0% of business funding in Kenya is sourced from banks compared to approximately 1.0% from the capital markets, according to the World Bank, mainly due to underdevelopment of the capital markets. This shows that our capital markets remain subdued compared to other economies, and access to funding remains a concern. The upshot is that there is banking dominance in Kenya, which then makes capital hard to access, and when accessed, it is expensively priced. It is important to have continuous education for current and potential investors to enable them understand the capital markets products on offer, including private offers. This will lead to further deepening of our capital markets and provide more funding to businesses.

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