AN INTRODUCTION TO THE INVESTMENT ENVIRONMENT

The Investment Process Explained

What's the Big Idea?

Imagine you are a farmer in Mashonaland West with a successful maize harvest. You've sold your crop and now you have a significant amount of cash. You have two choices. You could spend all the money now, or you could take a portion of it and use it to ensure an even bigger harvest next year. You might use the money to buy higher-quality seed, invest in a new irrigation system, or purchase more land. You are choosing to use your money today not for consumption, but to generate more money in the future. This is the essence of investing.

Investing is the act of committing money or capital to an asset with the expectation of generating a future income or profit. It's the process of making your money work for you. While the farmer invests in physical assets like equipment, in the financial world, people and companies invest in financial assets, like stocks on the Zimbabwe Stock Exchange (ZSE), government bonds, or units in a money market fund.

The investment process is a logical, step-by-step journey that an investor takes to make smart and disciplined investment decisions. It’s a roadmap that guides you from setting your financial goals to choosing the right investments and, crucially, monitoring their performance. It turns investing from a random guess into a structured plan.

Key Vocabulary

• Investment: The allocation of money to an asset with the expectation of generating a positive return in the future.
• Asset: A resource with economic value that an individual or company owns with the expectation that it will provide a future benefit.
• Return: The gain or loss of money on an investment over a certain period, usually expressed as a percentage of the initial investment.
• Risk: The chance that an investment's actual return will be different than expected. This includes the possibility of losing some or all of the original investment.
• Portfolio: A collection or combination of different investments owned by an individual or an organisation.
• Asset Allocation: The strategy of dividing an investment portfolio among different asset categories, such as stocks, bonds, and cash.

The Core Concepts Explained: The Five Steps of the Investment Process

A disciplined investor, whether a large pension fund like NSSA or an individual saving for retirement, follows a structured five-step process. As an investment administrator, your job is to help facilitate different parts of this process on behalf of your clients.

1. Setting Investment Objectives (Defining the Goal)

   This is the most important first step. Before any investment is made, the investor must clearly define what they are trying to achieve. An objective must be specific and consider both the desired return and the acceptable level of risk. A young person saving for retirement in 40 years can afford to take more risks to get a higher return. An elderly person who needs a stable income from their savings needs a low-risk objective. The objectives determine the entire investment strategy. For example, is the goal to preserve capital, generate a steady income, or achieve aggressive capital growth?

2. Establishing an Investment Policy (Creating the Strategy)

   Once the objectives are set, a formal policy or strategy is created. The most important part of this stage is asset allocation. The investor decides how to divide their money among different types of assets. For example, a low-risk investor might decide to put 70% of their money into stable Government Bonds and 30% into a few blue-chip stocks on the ZSE. A high-risk investor might do the opposite. This policy acts as the "rulebook" for the investor, guiding all their future decisions and preventing them from making emotional, panicked choices when the market fluctuates.

3. Selecting the Specific Assets (Choosing the Investments)

   With a clear policy in place, the investor can now choose the specific assets to buy. This involves research and analysis. If the policy says to invest in stocks, which specific companies on the ZSE should be chosen? Econet? Delta? Simbisa Brands? The investor will analyse the financial health and future prospects of these companies to select the ones that best fit their strategy. This is where the work of stockbrokers and financial analysts becomes critical.

4. Implementing the Plan (Executing the Transactions)

   This is the stage where the actual buying and selling of investments occurs. The investor gives instructions to a broker or an investment manager to purchase the selected assets on their behalf. As an investment administrator, this is where your role often begins. You will be responsible for processing these transactions accurately, ensuring the correct number of shares are bought at the correct price, and that the client's account is updated correctly. This step turns the investment plan into a real investment portfolio.

5. Monitoring the Portfolio and Measuring Performance (Reviewing and Rebalancing)

   Investing is not a "set it and forget it" activity. The investment process is a cycle. The investor must regularly monitor the performance of their portfolio. Are the investments meeting the original objectives? How does the portfolio's return compare to the overall market (e.g., the ZSE All-Share Index)? Based on this review, the investor may need to rebalance the portfolio by selling some assets and buying others to bring it back in line with their original asset allocation policy. This regular monitoring ensures the investment plan stays on track to meet the long-term goals.

Various Types of Investors

What's the Big Idea?

The financial market is like a large, bustling marketplace, such as Mbare Musika. At the market, you find many different types of participants. There are individual shoppers buying vegetables for their family's dinner. There are small restaurant owners buying in bulk for their business. And there are large-scale wholesalers buying truckloads of produce to distribute to supermarkets across the country. Each participant is there to buy and sell, but their size, their goals, and the amount of money they have are vastly different.

The investment world is exactly the same. The market is filled with different types of investors, each with their own unique characteristics, objectives, and resources. On one end of the spectrum, you have an individual student making their very first small investment through a mobile app. On the other end, you have a massive institution like a pension fund that manages billions of dollars on behalf of hundreds of thousands of people. Understanding the differences between these investors is crucial because their needs, behaviours, and the regulations that govern them are completely distinct.

Key Vocabulary

• Investor: A person, company, or other entity that commits capital with the expectation of receiving a financial return.
• Retail Investor: An individual investor who buys and sells securities for their own personal account, not for another company or organisation.
• Institutional Investor: A large organisation, such as a pension fund, insurance company, or bank, that pools large sums of money and invests it in securities, real estate, and other assets.
• Risk Appetite: The level of financial risk an investor is willing to accept in pursuit of a return.
• Sophistication: The level of knowledge and experience an investor has regarding financial markets and investment products.

The Main Types of Investors

We can broadly classify investors into two main categories: Individual Investors and Institutional Investors.

1. Individual Investors (Retail Investors)

   This category includes any individual who invests their own money for their own personal goals. They are the most common type of investor, though the amount of money they invest is typically much smaller than that of institutions. Within this group, there is a wide range of risk appetites and sophistication. For example, an elderly retiree looking for a safe and stable income is a very different individual investor from a young tech entrepreneur who is willing to take big risks for potentially high rewards. Banks and investment firms often further segment these individuals based on their wealth and needs (e.g., mass market, high-net-worth).

2. Institutional Investors

   These are the giants of the investment world. They are large organisations that pool money from many different sources and invest it on a massive scale. Because they manage such large sums, their actions can have a significant impact on the financial markets. Their primary role is to act as specialised financial intermediaries, managing funds on behalf of their clients or members. The main types of institutional investors in Zimbabwe include:

   • Pension Funds: These are funds set up by employers to provide retirement income for their employees. Organisations like the National Social Security Authority (NSSA) or the pension funds for large companies are some of the biggest investors in the country. Their primary objective is long-term, stable growth to ensure they can meet their pension obligations to future retirees.
   • Insurance Companies: Insurance companies, such as Old Mutual or First Mutual Life, collect money from the public in the form of insurance premiums. They invest this large pool of money (called the "float") so that it grows and is available to pay out any future claims. They typically follow a conservative investment strategy to ensure the safety of the principal.
   • Asset Management Companies and Unit Trusts: These are firms that specialise in managing investment portfolios on behalf of their clients. They pool money from many individual and institutional investors to create a large, diversified fund, such as a Unit Trust or a Mutual Fund. For a small minimum investment, an individual can buy "units" in this fund and gain access to a professionally managed portfolio, which would be difficult to create on their own.
   • Banks: Banks themselves are major institutional investors. They invest their own capital and can also offer investment products and asset management services to their clients through their wealth management or private banking divisions.
   • Endowment Funds and Foundations: These are funds that are set up by institutions like universities, hospitals, or charities. The fund's capital is invested, and the institution then uses the investment returns to help fund its operations or specific projects. For example, a university might use the returns from its endowment fund to pay for student scholarships.

Distinguishing Between Investment, Speculation, and Gambling

What's the Big Idea?

Imagine three farmers in the Honde Valley, each with some extra money. The first farmer uses her money to buy high-quality banana plantlets, fertiliser, and a small irrigation pump, planning to carefully cultivate them for a profitable harvest over many years. The second farmer hears a rumour that the price of avocados is going to shoot up next month, so he uses all his money to buy as many avocados as he can from other farmers, hoping to quickly sell them for a massive profit if the rumour is true. The third farmer takes his money to a local casino and bets it all on a single spin of a roulette wheel.

All three are using money in the hope of getting more money back. However, the fundamental nature of what they are doing is completely different. The first farmer is investing, the second is speculating, and the third is gambling. In the world of finance, people often use these terms interchangeably, but for a professional, the distinction is critically important. Understanding the difference is key to understanding risk, making responsible financial decisions, and providing ethical advice to clients.

Key Vocabulary

• Investment: The act of committing capital to an asset based on thorough analysis, with the expectation of a reasonable return over a longer-term period. The primary focus is on preserving the initial capital.
• Speculation: The act of engaging in a risky financial transaction in an attempt to profit from short-term fluctuations in the market value of an asset. The primary focus is on the price change itself, not the underlying value of the asset.
• Gambling: The act of wagering money on an event with an uncertain outcome, where the outcome is largely a matter of chance and there is no analytical basis for the decision.
• Fundamental Analysis: The process of evaluating an asset's intrinsic value by examining related economic and financial factors (e.g., a company's earnings, management, and industry conditions). This is the hallmark of investing.
• Risk: The probability or threat of damage, injury, liability, loss, or any other negative occurrence. In investing, it is the chance of losing your principal.

A Clear Distinction

While all three activities involve committing money with an uncertain outcome, they differ fundamentally in terms of their time horizon, the basis for the decision, and the level of risk involved.

1. Investment

   An investment is a carefully considered decision based on thorough analysis. The investor studies the fundamental value of the asset. For example, an investor buying shares in Delta Corporation on the Zimbabwe Stock Exchange would first analyse the company's profitability, the quality of its management, its position in the market, and the overall health of the economy. The primary motivation is to earn a return from the asset's intrinsic value, such as through dividend payments and the gradual, long-term growth of the company. The time horizon is typically long (years, not months or days), and while there is always some risk, the primary goal is the preservation of the initial capital.

2. Speculation

   A speculation is a decision based primarily on market psychology and expected price movement, rather than on fundamental analysis. The speculator is not interested in the long-term intrinsic value of the asset; they are betting that they can buy it and sell it to someone else for a higher price in a short period of time. For example, a person who buys a particular cryptocurrency purely because they heard a rumour that its price is about to "go to the moon" is speculating. Their decision is based on hope and market sentiment, not on a deep analysis of the asset's value. The time horizon is short (days, weeks, or months), and the risk of losing the entire principal is substantially higher than in investing.

3. Gambling

   Gambling is a decision based on pure chance, with no analytical basis whatsoever. It involves placing a wager on an uncertain event where the odds are typically stacked against the participant. Examples include betting on a horse race, playing the lottery, or putting money on a spin of a roulette wheel. The outcome is random and unpredictable. There is no skill or analysis that can reliably influence the result. The time horizon is immediate, and the risk is absolute— you either win, or you lose your entire stake. Unlike investing or even speculating, there is no underlying asset; it is a zero-sum game.

Characteristics of Various Investment Avenues

What's the Big Idea?

Once an investor has a clear plan and understands the difference between investing and speculating, they face the big question: "Where do I actually put my money?" The world of investments offers a huge variety of options, which we call investment avenues or asset classes. Just as a farmer can choose to plant maize, tobacco, soya beans, or horticultural crops, an investor can choose to put their capital into different types of assets.

Each investment avenue has its own unique set of characteristics, including its potential for return, its level of risk, how easily it can be bought and sold (liquidity), and how it behaves in different economic conditions. A professional investor knows that the key to successful investing is not to put all their money in one place. Instead, they build a diversified portfolio by combining different asset classes. This is like a farmer planting different crops; if a drought affects the maize, the more resilient sorghum crop might still do well. Understanding the main investment avenues is essential for constructing a balanced and robust investment strategy.

Key Vocabulary

• Investment Avenue (or Asset Class): A category of assets with similar characteristics, risks, and behaviours in the marketplace.
• Liquidity: The ease with which an asset can be converted into cash without affecting its market price.
• Tangible Asset: An asset that has a physical form, like a building or a piece of gold.
• Intangible Asset: An asset that does not have a physical form, like a share in a company or a patent.
• Security: A tradable financial asset. The term is often used to refer to stocks and bonds.

The Core Concepts Explained: The Main Investment Avenues

We will explore the characteristics of four major investment avenues that form the building blocks of most investment portfolios.

1. Financial Assets

   This is the broadest and most common category of investments. Financial assets are intangible; they represent a legal claim on a future income or the value of a company. They are the primary tools of the financial markets and can be broken down into two main types. The first type is equities (or stocks/shares), which represent ownership in a company. When you buy a share of Econet on the Zimbabwe Stock Exchange (ZSE), you become a part-owner of the company. Your potential return comes from an increase in the share price (capital gain) and from a share of the company's profits, paid out as dividends. Equities are generally considered higher risk but offer the potential for higher returns. The second type is debt securities (or bonds), which represent a loan made by an investor to a borrower (a government or a company). When you buy a Government of Zimbabwe Treasury Bill, you are lending money to the government. Your return is the fixed interest that the borrower pays you. Bonds are generally considered lower risk than equities and provide a more predictable income stream.

2. Real Estate

   This investment avenue involves purchasing tangible, physical property. Real estate is land and any buildings on it. For many Zimbabweans, it is the most familiar and trusted form of long-term investment. An investor's return from real estate can come in two forms: firstly, from rental income, which is the regular cash flow received from leasing the property to tenants. Secondly, from capital appreciation, which is the increase in the market value of the property over time. Real estate is considered a good hedge against inflation because property values tend to rise along with the general cost of living. However, its main characteristic is its illiquidity—it is very slow and expensive to convert a property back into cash compared to selling a financial asset. It also requires significant capital to get started and involves ongoing costs like rates, maintenance, and insurance.

3. Derivatives

   Derivatives are a more complex and advanced type of investment. A derivative is a financial contract whose value is derived from an underlying asset, such as a stock, a commodity (like gold or maize), or a currency. The most common types of derivatives are futures and options. Instead of buying the asset itself, you are buying a contract that gives you the right or the obligation to buy or sell the asset at a pre-agreed price on a future date. Derivatives are primarily used by sophisticated and institutional investors for two main purposes: hedging (to protect an existing investment against price movements) and speculation (to make a high-risk bet on the future direction of a price). Due to their complexity and the high level of leverage involved, they are generally considered very high-risk and are not suitable for most retail investors.

4. Asset-Backed Securities (ABS)

   This is another sophisticated financial asset. An Asset-Backed Security is created through a process called securitisation. This process involves a bank or other financial institution bundling together a large number of illiquid assets that generate a cash flow (like car loans, mortgage payments, or credit card debt) and then selling shares, or securities, in that pool of assets to investors. The investor who buys an ABS is essentially buying a right to receive a portion of the future cash flows from the underlying pool of loans. The main characteristic of an ABS is that it allows investors to invest in a diversified pool of debt, and it allows the original lender (the bank) to get the loans off its books and free up capital to make new loans. These are complex instruments primarily traded between institutional investors.

Factors Influencing the Selection of Investment Alternatives

What's the Big Idea?

Imagine you are deciding which major to study at the University of Zimbabwe. You wouldn't make this decision randomly. You would think about several factors. What subjects are you good at? What are your career goals? What is the potential salary for graduates in that field? Are there job opportunities in Zimbabwe for that profession? Your final choice would be a balance between your personal circumstances and the external realities of the job market.

Selecting an investment is an identical process. An investor doesn't simply pick a stock or a bond at random. Their choice is a carefully balanced decision influenced by a combination of their own personal situation (internal factors) and the wider economic and political environment (external factors). A young, high-income doctor in Harare will have a very different set of circumstances and will likely choose a different investment portfolio than a retired farmer in Chegutu. Understanding these influencing factors is the key to creating a suitable and successful investment strategy.

Key Vocabulary

• Investment Objective: The specific financial goal that an investor is trying to achieve.
• Risk Tolerance: An investor's emotional and financial ability to withstand losses in their portfolio.
• Time Horizon: The length of time an investor expects to hold an investment before they need to sell it.
• Economic Climate: The overall state of the economy, including factors like inflation, interest rates, and economic growth.
• Regulatory Environment: The set of laws, rules, and government policies that affect investment activities.

The Influencing Factors

The decision to choose one investment avenue over another is influenced by a blend of internal (personal) and external (environmental) factors.

A. Internal Factors (The Investor's Personal Circumstances)

1. Investment Goals and Objectives

   This is the most important starting point. The specific goal of the investment will heavily influence the choice of asset. An investor whose primary goal is the preservation of capital (i.e., not losing their initial money) will choose very safe investments like government bonds or fixed deposits. An investor whose goal is long-term capital growth will be more inclined to choose equities (stocks) on the ZSE, which offer higher growth potential but also come with higher risk. Someone who needs a regular income, like a retiree, will prefer investments that pay consistent dividends or interest.

2. Risk Tolerance

   This refers to the investor's psychological and financial ability to handle market fluctuations and potential losses. Some people are naturally risk-averse and would lose sleep over a small drop in their portfolio's value; they are better suited to low-risk investments like bonds. Other people have a higher risk tolerance and are comfortable with market volatility in the pursuit of higher returns; they may be more suited to equities or even more speculative assets. A good financial advisor spends a lot of time helping a client understand their true risk tolerance.

3. Time Horizon

   This is the length of time the investor plans to keep their money invested before they need to access it. An investor with a long time horizon (e.g., a 25-year-old saving for retirement) can afford to invest in higher-risk, higher-growth assets like stocks, because they have plenty of time to recover from any short-term market downturns. An investor with a short time horizon (e.g., someone saving for a house deposit in two years) must choose safer, more stable investments because they cannot afford a large loss so close to their goal.

4. The Amount of Capital Available

   The amount of money an investor has will also influence their choices. Some investment avenues, like direct investment in real estate, require a very large amount of initial capital, putting them out of reach for many small investors. Other products, like Unit Trusts, are specifically designed to allow investors with a small amount of capital to get access to a professionally managed and diversified portfolio.

B. External Factors (The Broader Environment)

5. The Economic Climate

   The overall health of the Zimbabwean economy has a massive impact on investment decisions. During periods of high inflation, investors will avoid holding cash (as it loses value quickly) and will seek out "real assets" like real estate or stocks in strong companies that can pass on price increases to customers. The level of interest rates, set by the RBZ, is also critical. When interest rates are high, fixed-income investments like bonds and fixed deposits become more attractive. When interest rates are low, investors are more likely to move their money into equities in search of a better return.

6. The Political and Regulatory Environment

   Political stability and a predictable regulatory environment are crucial for attracting investment. Investors are drawn to countries with clear, stable, and business-friendly policies. A sudden change in government policy, such as an unexpected new mining tax or changes to property rights, can create uncertainty and make investors hesitant to commit their capital. A clear and stable regulatory framework gives investors the confidence they need to make long-term plans.

7. The Performance of Financial Markets

   The current trend in the financial markets, often described as a "bull market" (when prices are generally rising) or a "bear market" (when prices are generally falling), influences investor sentiment. During a strong bull market on the ZSE, more people are likely to be optimistic and willing to invest in stocks. Conversely, during a bear market, fear can take over, and investors may sell their stocks and move their money into safer assets like cash or government bonds.

8. Tax Laws

   The government's tax policies can make certain investments more or less attractive. For example, the government might make the interest earned on certain types of bonds tax-free to encourage people to invest in them. Similarly, the level of capital gains tax (the tax on the profit made from selling an asset) and the dividend tax rate will influence the net return an investor actually receives, which will affect their choice of investment.