FINANCIAL NOTEBOOK - Q&A with CMMB Securities

Q. Last week you suggested that for some people it could be more lucrative to invest in the stock market than open their own business, I don’t get it. Even if it’s possible, won’t that take away from the sense of fulfilment, etc that comes from running your own business?

Davin, St. Augustine

A: To understand this perspective clearly let us go back to first principles. A fundamental reality of the economic system is that the factors of production, which are land, labour and capital, are scarce. Therefore, economic agents, in choosing to use resources in a particular way are incurring an opportunity cost, which is the benefit of the next best alternative. As a result, the economic system would want resources to flow to the most efficient producers in order to optimise the use of resources.  The way the system achieves this is by aligning individual self-interest with the system-wide objective of resource optimisation. In other words, the persons who make the most money from resources for themselves and the system as a whole are the ones who would obtain the most resources. For example, the entrepreneurs whose businesses are most profitable are the ones who would get the most capital from the banks and hire the best talent. Similarly the companies listed on the stock market, which yield the best returns, are the ones whose shares would appreciate because of the increased demand from investors.

In this way the interest of the investor as well as the system are aligned. The investor gets the best return for his capital and the system allows more capital to flow to that company who is able to pay such a good return on capital. Applying this to the question of opening your own business, the reasoning is clear. If you can earn the same or more by just buying shares on the stock exchange, from a purely economic point of view, you would not want to open your own business because not only is it a cost in terms of monetary value, but it is also a drain on your time which could be used in doing something else which could earn you even more money.

Only if the return from your own business exceeds the return from the stock market plus the extra income you can earn from having more time should a business be opened up. My guess is that it is only in rare circumstances that a start-up business would make more than the large companies in certain economic sectors of the local stock exchange, never mind the costs in time. By following this principle, only entrepreneurs who can outperform the stock market, ie the next best alternative, would open businesses and hence resources would be optimised. Individuals who cannot outperform the market would give their funds to the listed companies, which would be able to grow and expand, employ more people and pay more taxes to the Government, which would eventually result in more public goods and a higher standard of living. The investors who do not open their own businesses but invest in the stock market would now have more time to invest their skills in other areas.

Q. How do I go about setting up a “blind trust”?

Martin, Westmoorings

A: A blind trust is a device where an individual hands over the management of his wealth to trustees in trust for beneficiaries being himself and others he may appoint. The trustees in this arrangement have full discretion over the investment policy, which cannot be disclosed to the beneficiaries. In Trinidad and Tobago individuals going into public office usually utilise a blind trust. For example someone entering the political arena may decide to hand over the management of his funds so that he is safeguarded from accusations that he may use his authority for self-aggrandisement. The concept of the blind trust is recognised in Canada and Australia but is unknown in English law. It has been given statutory expression in Trinidad and Tobago by the Integrity in Public Life Act, No 8 of 1987, s 21.

Under the statute, the individual setting up the trust must pass a copy of the deed to the Integrity Commission. The income derived from the management of the assets is to be distributed to the beneficiaries as agreed. If his assets are converted to other assets the fact must not be communicated to him until he ceases to be a person in public life. For an individual not in public life a blind trust may not be very useful. If you want to set up an arrangement where your funds are administered for your benefit you can do so through the establishment of a trust fund. In such an arrangement you can appoint different types of beneficiaries. The income beneficiaries are given periodic distributions from the assets of the fund, which may be you and your spouse. Then, you can also appoint beneficiaries known as remaindermen, who would inherit the funds after all the income beneficiaries have passed on.

Q. In many countries they have a central point for monitoring people’s credit ratings, do we have anything like that in T and T?

Patricia, San Juan

A: No unfortunately there is currently no full-fledged mechanism by which banks can have access to objective data. Normally if a bank needs a credit reference they would write to another bank to get a qualitative not a quantitative report on the status of that customer’s finances. In such reports there are no details on which to make proper credit decisions and even if the bank gives a customer a good financial bill of health there is no way of knowing whether that information is accurate or subjective. This also affects the customer, as there is no objective way of building a credit history through hard data. Therefore there is no opportunity for a customer to improve his “rating” as there is no classification scheme or rankings which are updated from time to time neither is there any scientific criteria which is followed. There is thus a significant need for a Credit Bureau dedicated to this type of activity. There are unsubstantiated reports that the banks have appointed a private firm from which they can all get information on prospective or existing customers. However, any properly functioning credit bureau, that must be independent or seen to be independent, should operate as an arm of the state and we are still far away from that.

Questions can be sent so Po Box. 1830, Wrighston Road, Port-of-Spain
E-mail :cmmbsecurities@mycmmb.com