Signifying a major shift in its business model from repurchase agreements to mutual funds and unit trusts, Scotia DBG Investments (SDBG) has become the dominant player in the market for the combined collective investment schemes with 52 per cent of the US$347.9 million ($31 billion) market.

This is according to CEO Anya Schnoor, who also revealed that the wealth management and investment arm of Scotiabank also holds the majority of the unit trust market.

As at the end of July 2010, unit trust funds at SDBG were 58.7 per cent of the $17.92 billion total assets of the unit trust industry, which includes unit trusts managed by Pan Caribbean Investments, Barita Investments and Capital and Credit Fund Managers. This comes seven months after the International Monetary Fund (IMF) recommended that the securities sector reduce its reliance on repos.

Schnoor reports that over the past 12 months, off balance sheet products, the majority of which is in unit trusts ,has grown by over $15 billion.

“Our off balance sheet strategy is focused on reducing our reliance on repo funding while also transferring the underlying risk of the assets we hold to the client,” said Schnoor. “This strategy is consistent with the direction outlined in the IMF’s letter of intent and also reduces the company’s reliance on net interest income as its major source of revenue.”

Following its assessment of the financial system, the IMF, with which Jamaica has a standby arrangement, recommended a shift from the repo model to ‘off balance sheet’ products which would remove the risks from the institutions. With the repo model, the customer makes a short term investment with a guaranteed rate of return but does not directly take on the risk of the associated GOJ instrument. The risk remains with the dealer. The IMF and local regulators agrued that this model should be substantially removed over time.

“At the same time, in order to provide a viable investment alternative to repos, the authorities will focus on developing the collective investment scheme sector over the long term,” The IMF argued.

The market dominance by SDBG suggests that the entity is successfully making the transition to the more desirable products. However, the effects of the transition is not yet fully reflected in its bottom line.

In its third quarter results, SDBG saw a 30 per cent fall off in profits for the three months ended July 31, 2010 when compared to the similar period in 2009. Among the causes named for the decline was the reductions in net interest income as a result of participation in the Jamaica Debt Exchange (JDX) program and a general reduction in interest rates on Government of Jamaica securities.

Consequently, a 43 per cent gain on fees and commission income to $114 million for the quarter as well as an eight per cent increase in foreign exchange trading income and a decline of 24 per cent in salaries and benefits, were not enough to offset the reduction in interest income, securities trading and an increase in other operating expenses.

Interest income and net interest income reduced 42 and 23 per cent respectively over the quarters. Securities trading returned a loss of 25 per cent from $37.96 million in 2009 to $28.4 million in the period under review, while other operating expenses inched up 8.4 per cent to close the quarter at $84.5 million. This is why, Schnoor said the company has shifted its strategy to focus on the off-balance sheet investments.

“As the JDX programme has demonstrated when you rely on one product or source of revenue this creates shocks to your bottom line if that one source is impaired,” she said.

SDBG’s net profit pulled in $338 million in the quarter ended July 2010, a 30 per cent reduction from the $485 million recorded in 2009. However, when compared with the quarter ended April 2010, net profit was 40 per cent up over the $202 million at that point. According to Schnoor, this is an indication of improved performance during the year following the JDX.

“The improvement in our third quarter over the second quarter confirms that the decisions taken earlier in the year to consolidate our branch network, cut operating expenses and aggressively grow our non-interest revenue business are beginning to bear fruit,” she said.

“While we are leading the market in transforming our business model, we believe the strategy to be prudent and we have demonstrated that a consistent focus can achieve significant results,” Schnoor said. “This focus will allow us to transition our business model quickly and meet the new regulatory and other changes which the industry will have to face over the next 24 months.”

SDBG sells unit trusts and mutual funds through local entities Scotia Mutual Funds and Caribbean Income Fund.