High demand for bonds squeeze rates

By James Anyanzwa

Earnings on bonds have dropped on average by 80 basis points (0.8 percentage points) in the last year as investors fled the stock market for new opportunities in the fixed income market.

Market statistics show returns on two and five-year bonds fell to 9.1 per cent and 10.4 per cent on August 7, 2009 from 10.1 per cent and 11 per cent respectively over the same period last year.

The coupon rates on 10-year and 20-year bonds plunged to 12 per cent and 13 per cent from 12.3 per cent and 14.9 per cent respectively while that on a 15-year remained steady at 13 per cent.

Increased bond prices

This implies new investment in fixed income securities earn less now that it was a year earlier.

"As more investors shift to bonds, the demand for bonds is likely to rise, leading to an increase in bond prices and a corresponding decrease in yields. We have already begun seeing these effects on the bond market," says Mwebesa Ngoregamba, managing director, CFC Stanbic Financial Service Ltd.

"The equities market may however offset these effects if it stages a sustained recovery."

A comparison of last year and current year yield curves shows that yields have indeed been declining, and this effect appears to have been more profound on medium term bond yields.

Bond prices and yields have an inverse relationship. As bond prices rise, yields decline, and vice-versa. Improved demand for bond bids up prices thereby prompting a decline in yields. Fund managers have projected earnings, particularly on medium to long-term bonds to drop significantly on fears of rising oil prices, prolonged bear-run in the stock market and renewed demand from the diaspora.

They argue that with overall inflation staggering at 17.78 per cent, negative real return on Treasury Bills paying between 7-8 per cent may cause investors to start thinking in long term.

The improved activity in bond market is mainly happening in primary auctions, which are dominated by institutional investors.

Primary market

"The trading volumes are still fairly low for the fixed income securities market. The improved activity we are witnessing is occurring in the primary market," Mwebesa told the Financial Journal last week.

Over the years, most companies have preferred bank loans to the capital markets while seeking funds for expansion programmes. "But this trend is changing as we go forward," says Mwebesa.

Indeed, CFC Stanbic Bank has successfully raised Sh2.5 billion through a bond issue while other companies such as KenGen, Centum Investment Ltd, Safaricom and Shelter Afrique are also readying to sell their bonds.

According to Mwebesa, the high inflation experienced since 2008 has not had the expected push-up effect on interest rates because money supply/liquidity and investor ‘flight to safety’ have played the major role in determining investor decisions.

"Interest rates have had no effect on exchange rates, which over the past year have been determined by trade flows and foreign investor exit from NSE," he says.

Global crude prices

Uncertainty over the expected recovery of equity market and the renewed upsurge in global crude prices have also led Kenyans in the diaspora to consider depositing 40 per cent of their local investments in the bond market.

Official data indicates that the NSE 20- Share Index fell from 5444.83 per cent in January 2008 to 3262.92 by end of last Friday.

"The debt market in general will start to experience a decline in interest rates," says John Wakiumu, head of fund management and research at Amana Capital Ltd adding that "bond prices will go up, but this is attractive for those holding these securities now."

The Government has been lengthening the maturity profile of treasury bonds with a view of facilitating an effective pricing mechanism of long-term debt securities by the private sector.

Currently, the Government has bonds with maturities ranging from one year to 20 years.

The equity market witnessed a flight to safety in the first six months of 2009 with investors shifting focus away from stocks to fixed income securities.

According to statistics from the NSE, the value of traded bonds increased by over 127 per cent to Sh28 billion in June from Sh65 billion in January 2009.

Equity turnover, on the other hand, dropped 65 percent to Sh12.32 billion by the end of June 2009 from 34.85 billion in the first six months of June 2008. The persistent bear market prompted institutional and high net worth retail investors to seek safety in government debt and alternative investments such as real estate.

The major players in the bond market include commercial banks, insurance companies, fund managers, and high net-worth retail investors with new interest from Kenyans in the diaspora.

The local debt market is expected to play a key role in mobilisation of domestic resources to finance the flagship projects identified in the country’s vision 2030.

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