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How pension funds reel from negative real interest rates

A collapse in yields on Nigerian assets is leaving pension fund administrators (PFAs) with no choice but to plough back pensioners’ funds into assets offering rates below inflation.

Nigeria’s biggest institutional investors, the PFAs, are reeling from a negative real interest rate environment, after a host of Central Bank of Nigeria’s (CBN) policies aimed at boosting growth in a fundamentally weak economy, restricted them alongside other local investors from investing in high yielding short-term OMO bills instruments.

That sparked a massive influx of liquidity into other asset classes, particularly T-bills and Bonds, sending the yields on these assets to lower lows below the rate of inflation.

Even though the PFAs are making a killing for now, from the bond rally, by trading a part of their already invested long-dated bonds, and using capital gains from these bonds to reward clients with interest above inflation; they are still faced with huge ‘reinvestment risk’ when they make a new purchase, forcing them to reward pensioners with returns far lower than inflation.

“The biggest challenge for most institutional investors, particularly the PFAs, is reinvestment risk,” said Yomi Sadiku, head of investment, Lagos-based pension firm, AIICO Pension.

According to Sadiku, as PFAs investment in OMO matures, they have to look for where to invest that money but they definitely cannot go into T-bills anymore because the rates are too low. “The bond markets that we could have gone to as well, the interest on the bond market is also very low. So, unfortunately, there is nowhere we can go.

“This year, a lot of the PFAs have classified their bond as available for sale, it would appear they have outperformed everybody else, because of course, as yields continue to go down, the price of these bonds go up, but next year, there is nothing they can do,” Sadiku said.

Average interest rates on short-term T-bills have tumbled to 1.3 percent from the high of 14 percent some two years ago, while yields on bonds are sitting as low as 7 percent, according to data from securities trading platform, FMDQ.

While the low-interest-rate environment has become a major win for both the Federal Government and large corporates, providing them soft landing to borrow at low cost, it has come with so much pain for pensioners whose funds are collected largely by the government but are rewarded with returns below the country’s inflation.

Between April and July this year, the Federal Government raised N7.74 billion in bonds, down by 3 percent from the N7.94 billion raised in the first three months of the year.

As at August 29, a total of N559.77 billion had been raised by large corporates from commercial papers, which is about 103 percent higher than the N275.37 billion raised in March, according to data from the FMDQ.

The case of a low-interest rate may not have been a big issue for investors—since interest rates on assets are still high when compared with what is obtainable in other climes.

It would also have not been an issue for a country looking to boost spending and consumption after suffering its deepest economic contraction in more than a decade by 6.1 percent in the second quarter of the year. But for the country’s spiralling inflation, which is eroding the real value of these assets, leaving investors and savers with nothing to cheer.

With commodity prices jumping to their highest levels in 29-month to 13.2 percent in August, real yields, arrived by deducting yields on an asset from the prevailing inflation rate, have largely been negative.

“With the negative real interest rate, it becomes the pensioners that will suffer because the fund managers will only pay out returns they get,” an investment expert, who has more than 25 years’ experience, said, noting that there was no guaranteed pension in Nigeria.

“In real terms, they are not making any money; instead they are losing because both inflation and market price are wiping out their investments.

“I suspect at this point, they are probably advocating to both CBN and the PENCOM regulator to relax the regulation that allows them to invest in non-Nigerian instruments, which is their biggest to hedge their asset, or there is a quick launch of Nigeria’s infrastructure fund to help give them some comfort,” the person said.

An inverse relationship exists between the price of an asset and the returns, meaning in a low yielding environment, particularly on bonds and fixed income assets like treasury bills, prices are expected to be high and vice versa.

Pension funds invest in a variety of assets, but most, including defined benefit plans, use low-risk assets such as government bonds as the benchmark discount rate. While that means they have profited from the fixed-income rally, falling yields have also driven up future liabilities — in turn threatening their ability to meet oncoming obligations.

In nominal terms, pensioners have seen assets under management hit over N11 trillion. Such growth has been wiped out in real terms due to successive devaluation of the naira.

With more than 56 percent of pension assets invested in Federal Government bonds, fund managers who spoke with BusinessDay said they have had to trade some portions of their bond holdings in line with their business policies, just so they could meet up with rewarding clients with returns higher than the country’s prevailing inflation rate of 13.2 percent.

Whichever the case is, they still can’t escape, since long-dated bonds which they have taken comfort in, is very sensitive to interest rate changes.

With average yields on bonds trading at their lower levels below 10 percent, analysts foresee either stagnancy or an upward reversal in the yield position.

That would mean a tapering of the bond rally, which fund managers and asset managers have cashed in on to reward high returns, according to Omotola Abimbola, a fixed income and macro analyst at investment and advisory firm, Chapel Hill Denham.

“It could also form the case for them to increase allocation to equities since returns on the bond side could be a lot more restrained next year, if there is no further downward push in the yields,” Abimbola told BusinessDay.

As expected, domestic participation in the Lagos bourse has seen an uptick from 40 percent to 61 percent, Oscar Onyema, CEO, Nigerian Stock Exchange, said in one of his presentations to clients.

The increased participation of local investors in equities is due to the low-interest-rate environment, which has positioned the exchange as a haven and viable market for the destination of private capital, Onyema said.

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