Old Mutual: Confirmation bias won’t cut it

That economic players in the country have been using the Old Mutual implied rate to determine the exchange rate to use in trading foreign currency and pricing their products is not debatable, it was widespread.

The Old Mutual Implied Rate (OMIR) is widely used in the economy as a key indicator of where the exchange rate between the Zimbabwe dollar and the US dollar should be going.

The OMIR is a principle that is used as an informal way of measuring the purchasing power parity between two currencies and provides a test of the extent to which market exchange rates result in goods costing the same in different countries.

The OMIR is used by economic players to predict exchange rate movements by suggesting that the Old Mutual share price should be the same in Zimbabwe and in South Africa in US dollar terms.

The OMIR principle is similar to the Big Mac Index, which is published by The Economist as an informal way of measuring the purchasing power parity (PPP) between two currencies and provides a test of the extent to which market exchange rates result in goods costing the same in different countries.

What makes the Big Mac Index work is the key assumption that no matter what currency the Big Mac burger is sold in, the cost of making it and subsequently the price charged must be the same.

For that to happen, the local McDonald’s franchisees at least in theory have significant responsibility for negotiating similar input prices, something which is key to enable comparison between many countries’ currencies.

The Big Mac PPP exchange rate between two countries is obtained by dividing the price of a Big Mac in one country (in its currency) by the price of a Big Mac in another country (in its currency). This value is then compared with the actual exchange rate; if it is lower, then the first currency is under-valued (according to PPP theory) compared with the second, and conversely, if it is higher, then the first currency is over-valued. A similar principle is used to come up with the OMIR. In theory the share price of Old Mutual Limited on the ZSE should be the same as that on the JSE.

As June 26, 2020 (the day trading was suspended on the ZSE) Old Mutual was trading at R11,71 or (US$0,67) on the JSE and $81,99 on the ZSE.

So for the ZSE price to match the US$0,67 on the JSE, one would have to divide the $81,99 by 122 to get US$0,67.

This makes 122 the OMIR or in other words the Zimbabwe dollar should have been trading at 122 to the USD and not the official rate of 57,35 as per the first auction rate.

While the ZSE is closed, and Old Mutual trading, one can still use the Old Mutual share price on the last trading day at $81,99 and today’s (July 15, 2020) Old Mutual share price on the JSE at US$0,76 to come up with an OMIR of 107 which is still above the official exchange rate of 68,8 as at the last forex auction on Tuesday.

We are, however, of the opinion that at the moment, the OMIR should not be used to determine where the exchange rate should be. The first thing is that it does not meet the key assumption that was made in coming up with the Big Mac Index.

As a recap, for the Big Mac Index to work, the key assumption is that the cost of making it must be the same. With the Big Mac Index, franchisees must have significant responsibility for negotiating input prices, something which is key to enable comparison between many countries’ currencies.

However, with the Old Mutual share price, there are so many variables why the price someone in South Africa is willing to pay differs from what someone in Zimbabwe is willing to pay.

For example, when Old Mutual was still fungible, an investor in Zimbabwe, desperate to take money out of the country, would pay a premium to get Old Mutual shares which would then be removed from the Zimbabwe register and sold on the JSE. At the same time, an investor on the JSE does not have the same pressure and would not pay a premium for Old Mutual shares because getting money out of South Africa is not a mission impossible as it is in Zimbabwe.

Another example why the price of Old Mutual varies between the ZSE and the JSE is that in the former, there are very few quality counters for investors to choose from. This means a large number of investors would look at the Old Mutual share as one of the few alternatives and would be willing to pay a premium for the share. However, an investor in South Africa does not only have hundreds of quality stocks to choose from, but also has other investment instruments to choose from such as ETFs, Bonds, Derivatives etc.

There are thus so many variables at play resulting in the same counter attracting different share prices at the same time on the two markets.

This can, however, not be blamed on the company. Old Mutual as a company does not determine what price investors pay for its shares. In any case there are circuit breakers in place at the ZSE that prevent abnormal movements in share prices. In fact, Old Mutual has this year failed to beat inflation and its returns in US dollar terms are negative. At 124 percent year-to-date gain, Old Mutual Limited’s performance is among the bottom 10 performers on the ZSE, a market which had record gains this year.

It is up to authorities and policy makers to work on the reasons why Old Mutual is attracting a premium on the ZSE than it does on the JSE. If it is because people do it so that they can get money out of the country, then that is what needs to be fixed. We need to fix our exchange rate policy so that investors do not resort to cumbersome processes to get money out of the country.

If it is because of limited investment options, then that’s what needs to be fixed. Why don’t we encourage other companies to list on the ZSE or FinSEC so that Old Mutual does not become one of the few alternative counters for investors. We should be introducing ETFs so that there are more options for investors to invest in. We should be making our prescribed assets attractive so that funds that are looking for an investment home can find one. Most pension funds and insurance firms are failing to meet their prescribed asset investment ratio, not for lack of will but for lack of viable options.

Just recently Treasury Bills issued by the central bank on behalf of the Government were rejected because there was no consensus on the interest rates. What the RBZ is comfortable with, investors do not find any comfort in.

Delisting Old Mutual from the ZSE is not the best solution because if some of the issues mentioned above are not resolved, nothing will stop economic players from coming up with other implied rates using the other dual listed counters such as PPC, Seed Co international among others. So delisting Old Mutual only sets the wrong precedent.

In any case, what is happening to Old Mutual is akin to confirmation bias as the information used to reach the delisting decision was distorted to support prior beliefs.–ebusinessweekly.co.zw

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