Investors should understand risk of investing in bills, bonds

By Odhiambo Ocholla

As Government accelerates retail investors’ participation in the fixed income market, it is important for the retail and less sophisticated investors to understand risks associated with these investments.

Reports indicate retail investors will soon be able to buy government debt including Treasury Bills and bonds using their mobile phones, according to a project in a pilot stage dubbed, ‘Treasury Mobile Direct’, launched by the World Bank and Central Bank of Kenya.

Though increased appetite for Treasury bills, bonds by retails investors is laudable, having topped Sh20.3 billion by end of last year, there is need to understand the risk that comes with them. Investors need to know you cannot have your cake and eat it.

Every investment has some degree of risk and volatility. To earn the higher returns, you have to take greater risk. Conversely, the least risky investments also have the lowest returns.

The Treasury bills and bond market is no exception. What we don’t know can hurt us. Investing too conservatively can be as damaging as investing too aggressively.

 Though the risk of investing in Treasury bills is less visible, it is real and potentially dangerous. Treasury bills and bonds have risk, too.

All investments offer a balance between risk and potential return. Since every investment carries some degree of risk, it makes sense to understand these risks and ways manage it.

 

Treasury bills

Treasury bills are some of the safest forms of investments in the world due to government backing. They are considered risk-free. There’s no guarantee the rates won’t crash. But you are guaranteed of the rates locked in when your investment matures.

 To illustrate this risk it’s important to note that the yield on the three, six-month and 364-day Treasury bills was 20.50, 20.72 and 20.95 per cent respectively by January. But by close of business last week the rates has declined to 11.38, 14.77 and 16.92 per cent respectively.

There’s also reinvestment risk. That means you must invest your cash again, or reinvest, at a lower interest rate. An investor who cares most about preserving capital, Treasury bills would appear more a safer bet than shares.

But the picture is quite different after adjusting for inflation. While inflation rate slowed 13.06 percent, 91-day Treasury bills rate is going for 11.38 per cent.

These means, Treasury bills rates are not keeping up with inflation. The lower return potential of Treasury bills casts doubt on their ability to preserve real wealth.

Yes, but it’s important for investors to remember there are risks to owning Treasuries, even though there’s no significant risk the government will default on its debt.

 

Treasury Bonds

A specific bond’s risk level is reflected in its yield, another name for return on a bond investment.

The higher the risk in a given bond, the higher its yield needs to be to compensate the investor for taking the risk.

When the market perceives the yield on a bond to be too low, its price will fall to bring the yield in line with market expectations or prevailing interest rates.

 When interest rates rise, bond prices fall. Conversely, when rates decline, bond prices rise. The longer the time to a bond’s maturity, the greater its interest rate risks. With the current high interest rates, most bonds have drop in value.

Successful investing requires a careful balance between fear and greed.

Retail investor’s objective in purchasing bonds can be seen as an attempt to earn a better yield compared to commercial banks deposit rates.

 The investor may have an opportunity to make capital gains from bond investment if the market interest rates fall. This therefore presents an additional advantage for bond investments over ordinary deposits.

 

Mr Odhiambo Ocholla is an Investment Banker.

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