Investor exposure to bond funds has tripled since the beginning of 2020 as they rotate from money market and equity funds to the higher-yielding fixed income funds.
Bonds, money market and equity funds are all types of Mutual funds.
A Mutual fund is a professionally managed investment scheme, usually run by an asset management firm that pools funds from a group of people and invests their money in securities such as bonds, short-term debt and stocks.
In the case of bond funds, the fund manager only invests in bonds while an equity fund invests solely in equities/stocks of listed companies, and a money market fund invests in short-term debt instruments like Treasury Bills.
The Net Asset Value (NAV) of Bond funds, a measure of the level of investment in the asset, has grown by a record 264 percent year-to-date to N165 billion as at July 3, from N45 billion at the beginning of the year, according to data from the Securities Exchange Commission (SEC).
That is nine times more than the 30 percent growth in the net asset value of the entire mutual funds market in Nigeria.
The relative attractiveness of bond funds this year stem from the higher yields they offer compared to other types of mutual funds. While a one-year Treasury Bill is yielding 3.5 percent, the 10-year bond is at 8.5 percent.
Nigerian equities on the other hand are down by 9.52% since the start of the year, and that has upended equity funds.
Although the 10-year bond fund is below inflation rate, which quickened to a 26-month high of 12.56 percent in June, but it still offers higher yields than any other mutual fund and that has caught the eye of investors.
Bond funds are also less risky than other mutual funds and as such the increased appetite could well be a reflection of the lack of investor confidence in the economy.
“Money is flowing to bond funds and away from some money market funds that can barely outperform the 3.75 percent paid on savings accounts,” notes Egie Akpata, a director at UCML Capital.
“Mark to market gains are massive on bonds due to the drop in interest rates,” Akpata added.
Eurobond funds outperform local bonds
Of the nine bond funds in Nigeria, the best performers in terms of year-to-date returns are the dollar funds, which mainly invest in Eurobonds as against the local bond fund that invests in local bonds.
The dollar funds, excluding the First Bank Nigeria Eurobond USD Fund (Institutional), which is down 89 percent year-to-date, have returned 11 percent compared to 6 percent for the local bonds.
The best performing bond fund year-to-date is the Legacy USD Bond Fund, which is managed by First City Asset Management Limited. The Fund’s unit price is up 17 percent from N306.5 at the beginning of the year to N360.5 as at July 3.
In second place is the United Capital Eurobond Fund, managed by United Capital Asset management, the unit price of the fund has gained 9 percent year-to-date to N44,660 from N40,746 in the period under review.
The PACAM Eurobond fund, managed by PAC Asset Management Limited is in third place with a 8.9 percent increase in its unit price to N41,506 from N38,101.
The Nigeria International Debt Fund, managed by Afrinvest Asset Management is in fourth place and has seen an 8.2 percent rise in its unit price to N218 from N210.
The United Capital Bond fund is the only local bond fund in the top five best performers in the year-to-date period. The fund’s unit price is up 8 percent to N1.83 from N1.69.
“The rally in Eurobond funds is driven by investors seeking high yields in a market marred by low returns, but more importantly, it is also becoming popular among investors seeking a hedge against the naira,” states Wale Okunrinboye, head of investment research at Lagos-based pension fund managers, Sigma Pensions Limited.
“While equity-based funds have been punished by Nigeria’s weak economic fundamentals, bond funds offer a safer option for investors,” Okunrinboye says.
Asked for his outlook for bond funds this year, Okunrinboye says the asset class is expected to perform better than other mutual funds as uptake continues to increase.
Equities defy logic amid falling rates
Bonds are rallying because of the sheer amount of liquidity in the market and that has seen interest rates collapse aggressively.
Ideally, there should be an inverse relationship between interest rates and the equity market, as lower interest rates mean lower funding costs for companies and lower yields for portfolio investors.
Hence, in an environment of low interest rates there is typically an increase in equity valuations.
“In conventional markets, we should see equity doing very well but Nigeria is a peculiar market. Money managers would rather hold negative real return fixed income instruments versus equity,” a fixed income trader at a tier-one bank notes.
“For equities – given the weak macro-economic backdrop, COVID-19 and low oil price environment – the earnings outlook of some companies are also in doubt so I can understand the hesitation of investors,” the trader says.
What mutual funds say about economy
Investors rotating out of equity funds into bond funds show the level of risk in the economy tipped to contract by 5 percent by the International Monetary Fund (IMF) in 2020.
Equities tend to reflect the level of investor sentiments towards the economy.
Investors rush into fixed income instruments when risks are heightened and safe haven assets are in demand.
The trend of investors piling into bond funds is also due to the country’s steep yield curve, which means longer-term rates far outweigh short-term rates.
“Nigeria’s yield curve is very steep, as there’s a huge gap between short and long-term rates,” according to Akpata.
A yield curve, in economics and finance, is a curve that shows the interest rate associated with different contract lengths for a particular debt instrument. Asked whether Nigeria’s steep yield curve is unique and how it compares to peers, Akpata states, “It is unusually steep in nominal and relative terms. Tbills got to under 4 percent per annum several months ago while bonds were still well over 10 percent. So, bond yields are dropping to meet T-bills and reduce the steepness of the curve.”
