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Today's Paper

Invest in both shares and bonds to cut risks

By Otieno Odhiambo | Published Tue, August 7th 2018 at 13:40, Updated August 7th 2018 at 13:43 GMT +3

The Nairobi Securities Exchange (NSE) deals in the investment of buying and selling of shares (stocks) listed in the market.

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Local dailies report the performance of the listed shares on a daily basis.

However, another key vehicle for investors that is mostly ignored is the bond.

When a government or company borrows money in the capital markets, it issues long-term debt securities to investors.

A bond is created when a borrower gets money from the lender. At a higher level, a bond is an instrument that promises to pay a lender a series of periodic interest payments in addition to returning the principal at maturity.

As an investor, you can either invest in shares or bonds.

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The prudent thing to do is to balance your risk by investing in both shares and bonds.

In any case, many companies raise money by borrowing rather than issuing of shares. This shows bonds are an important source of capital for businesses and governments.

When you invest in shares (stocks), you expect to receive dividends and possibly sell the stock at a price that is higher than what you paid for.

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For example, if you bought a share for Sh8.50, but you are now able to sell it at Sh11.50, making Sh3.10 per share.

Earn dividend

However, whether you will earn dividend or not depends on how the managers of the company whose share you hold chose their investments.

Only profitable companies pay dividends and that makes your returns from a share risky because companies can make or lose money.

When you invest in bonds, you have literally loaned out money and you expect to be paid interest and be refunded your principal on an agreed date. The borrower must pay interest on the amount borrowed as per schedule, failure to which it will expose them to a lawsuit or sale of the borrower’s assets.

Even before litigation, the market will devalue the shares of a defaulting borrower.

In most cases, bonds are secured, that is backed by a collateral. A collateral is an asset that a borrower offers for a lender as a security. Should the borrower fail to service the loan, the lender seizes the collateral, sells it and uses the proceeds to settle the loan.

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The bonds being traded at NSE are issued by large and medium-size companies, largely considered to be safe borrowers.

In addition, the Government raises funds by selling debt securities which include treasury bills, intermediate-term treasury notes and long-term treasury bonds.

A bond characteristic that makes it a relatively safer investment compared to shares is the bond indenture.

This is a contract between a firm that issues long-term debt securities and the lender, specifying the nature of the debt issue, the way the principal must be repaid and any restriction on the borrower’s activities.

Safer investment

Bonds offer a safer investment than stocks (shares).

However, investors are made aware that the returns from bonds in the long run, must be lower than the return from shares because shares are riskier.

This means that the returns from shares of a company are expected to be higher than returns from the bonds issued by the same company.

At the NSE, the trading activity of bonds is lower than that at stocks and information about stock trading is more visible and well-presented than information about bonds.

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The NSE information on debt financing activities is too scanty and newspaper articles on the same are not helpful either. In the US, the Wall Street Journal has articles and reports containing data on debt and bond activities.

The NSE could borrow a leaf from them on how to present useful information about bonds to investors at the bourse.

The NSE data on bonds is incomplete and can be improved on by including current and last prices, last yields, estimated spread, comparable treasury issue, bids and asked price.

The bourse can also do better by making the bond price and volume trading data affordable to those who have an interest in the bond markets, particularly students who are tomorrow’s investors and researchers.

At the Nairobi bourse, the bond data is overpriced and out of reach for most students interested in analysing bonds.

In any case, securities pricing is information-driven and such prices are only a fair representation of a security’s value.

-The writer teaches at the University of Nairobi  

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