Moemedi Malindah gathers a throng of editors to unpack for them how investment deals are structured and factors to consider when making an investment. The CEO of Botswana Public Officers Pension Fund (BPOPF) tells the editors that the objective of investing money is to back a deal with financial capital, intellectual capital and/or sweat capital in order to earn an expected return, given the risk taken.
“There is nothing like a risk-free investment,” he says. According to him, there is a level of risk in every investment. Because of this, Malindah emphasises that investment management is not avoiding risk but pricing right the risk exposure and being compensated fairly for the risk you take. However, he says, there are obvious red flags in an investment. “If the return is not commensurate with the risk, it is a deal to walk away from,” he says, adding that if the return is just too high given the level of risk, it is a great red flag because there is no free lunch.
But if the return is commensurate with the risk taken, it is subjected to other considerations. There is always the buy side and the sell side to a transaction. Malindah contends that the buy side would always want to pay at a discount of their valuation while the sell side would want to sell at a premium to their valuation. “The negotiation is to get to the fair price for the buyer and the seller,” he says. “Whoever has some bargaining power however, can tilt the equation in their favour.”
Malindah cautions that paying too much for an investment deal sets one up for a difficult investment life. This is because in the long-term, a business or investment will revert to its true price, if it was overpriced. In investment terms, there is what Malindah calls mean reversion, which is a financial term for the assumption that an asset’s price will tend to converge to the average price over time.
However, if one pays at a discounted price for an investment deal, one would have set themselves up for a less difficult investment life. Malindah says when someone approaches an investor to pitch, they usually have “the best deal ever”. But that may not be the true reflection of the business. “We hear that a thousand times a year,” says the CEO of BPOPF, adding that investing in these “”best deals ever” may result in losing money.
According to him, it is all about understanding the risk, the opportunity, and the price. He advises further that an investment should never be made an emotional exercise. To give an example, he says on average, for 100 deals that investors usually evaluate, only about 20 are worth pursuing. And out of the 20, three to five are worth the investment. Malindah advises that before pouring money into an investment, one must sniff out the so-called best deals ever and avoid losing money. Investors must ensure that good due diligence is conducted, he emphasises.
Most importantly, Malindah adds, investors must understand that a good business is not always a good investment. To qualify that, he notes that a business may be making a lot of money and valued higher, but it may turn out that cash is burnt before reaching the pockets of investors. As an example, he says a lot of businesses in Botswana and abroad spend too much money on related party transactions and other operational costs. As a result, they tend to declare little or no profit despite making much money as revenue.
“You would find that the founders would have set up their own companies to benefit from related party transactions,” he says. “In that case, they do not care how much is declared to shareholders because they would have gotten their cut before profits are declared. If you invest in such a company, you will not get a return on your investment.”
At the same time, Malindah reveals that a bad business can be a good investment in that the business can be given technical backup or capital injection for it to turn around and make money. But it all boils down to an investment strategy. Malindah speaks of two strategies, an active investment strategy and a passive investment strategy. An Active investment is a form of investment strategy that involves actively buying and selling assets in the hope of making profits and outperforming a benchmark or index. An example of an active investor is a hedge fund manager who constantly monitors the market and trades when they see an opportunity to make money.
Passive investing requires buying an index fund that is mirrored to an indice or index. These funds are called passively managed or passive funds. The underlying holdings in these could be stocks, bonds or other assets that make up the index being tracked. Commonly known passive funds are index funds and ETFs.
In Malindah’s view, under an active investment strategy, investors do not believe the market is fairly priced all the time. They thoroughly scrutinise the investment, he says, beyond information provided by the market. “They just do not take what is being provided to them by the market as is,” he notes. This is unlike passive investors who always believe that the market is right and never question anything when investing. As an example, active strategy investors would at times question the share prices that depreciate in companies that record increases in profit.
“Passive investors would invest in the company looking at the profitability announced to the market at the time,” says Malindah. “An active strategy investor would investigate and sometimes find that profits are up because of a one off sale of some assets which would mean that the rise in profit would be a one off activity. Over time, the profit would decline.” He adds that an active investor does their homework before investing. Unlike passive investors, they strip and carefully study the financials to reveal hidden details. Even so, Malindah says passive investments can also outperform the active investments. However, he notes, there is no right or wrong investment strategy.
That being said, Malindah points out that it is dangerous for a manager to change strategies haphazardly. He says an investment manager must adopt a strategy and stick to it. “If they are not fully convinced of their investment strategy, they are going to lose your money,” he warns, saying the number one requirement of a solid investor is to not be fearful when everyone panics or to become as excited as the masses.
“History shows that 90 percent of the managers that dumped their strategy in the midst of the crisis underperformed,” he says. “Investment should be unemotional. So in your pursuit to determine whether things are done right, you might want to spend time understanding the strategy of the manager and how it has fared over the years.”
BPOPF operates through an active investment strategy that Malindah says has so far worked for the Fund. In 2020, it recorded the greatest one year growth of 26 percent from P59 billion to P75 billion in assets under management. Offshore equities grew from P34.8 billion to P50 billion. All this happened in the advent of the COVID-19 pandemic.
Malindah says he often receives questions about how did they performed so well when the economy was underperforming. “Our response is that we do not invest in the economy but in a select of companies that we believe perform well even against the odds,” he explains.