Fixed income investments enable the investor to know what range of returns to expect and so are preferred by conservative investors. However there are still uncertainties and risks involved, their size correlated to the yields they offer. Here are the options available in Ghana, the yields they can be expected to offer in 2019, and the respective levels of accompanying risk.
For risk adverse investors who are unwilling to take chances, fixed income instruments are the way to go; while they do not provide an opportunity to anywhere near double ones money – which a stock market can do in a very good year – most types ensure that one will make a profit; stock markets provide no such certainty. Indeed, the poor performance of the Ghana Stock Exchange during the second half of 2018, during which share prices fell sharply, serves as a convincing advert for fixed income securities, most of which generated returns of between nearly 14 percent and up to 36 percent last year.
This year, investors can expect similar returns on average from fixed income securities, while equity investors have no such certainty, as their investments could possibly be three times this – or could generate outright losses on the principal sums invested.
To be sure there are plenty of fixed income instruments to invest in, but they come with widely varying expected yields and accompanying risks. At one end are the only completely risk free instruments: cedi-denominated treasury bills, notes and bonds issued by the Government of Ghana which have no risk of payment default whatsoever but which will all pay less than 20 percent per annum in interest this year. Indeed, the shortest tenured ones, comprising 91 day and 182 day treasury bills will most likely pay somewhere between 13 percent and 14 percent.
Longer tenured treasury bonds of two years and longer offer rates of up to 19 percent currently. They are tradeable on the secondary market too which means an investor is not necessarily locked in for the entire tenor of the investment, but prices of the bonds change on the secondary market which change the effective yield to the investor. Therefore, it is advisable to seek professional advice before investing in a medium or long term government treasury bond.
At the other end are the short term investments being offered by Ghana’s micro finance, rural banking and savings and loans industries, of which the highest paying will offer yields of over 40% in 2019. In actual fact a few of these types of firms will offer higher yields but investors would be well advised to steer clear of them – risk and reward are positively correlated and so unusually high offered rates of return inevitably mean inordinate risk with end results along the lines of DKM Microfinance and Menzgold.
In between the highest and the lowest rates are a wide array of different types of fixed income investment and accompanying investment risk.
One is fixed deposits offered by various types of financial institution. The lowest rates are offered by the banks because they carry the lowest risk of default. Indeed following last year’s banking sector reforms the risk of default is now negligible. Banks tend to announce fixed deposit rates that are a little lower than treasury bill rates but this is a primarily a gambit aimed at minimizing their cost of funds. Indeed, investors with relatively small investments have to be guided by the rates offered by the banks but for those with large sums of investible funds – high networth individuals and institutional investors – they can negotiate a premium above the rate offered by treasury instruments for the same tenor as the fixed deposit to be invested in. This means that currently large fixed deposits can attract around 15 to 16 percent for a 91 day investment, this rising to over 20 percent for a multi year deposit. Investors can shop around for the best rates but should keep in mind that the lowest rates are offered by the safest banks and vice versa. But currently, all 23 banks still with licenses can be regarded as safe. However since fixed deposits are not securitized and therefore have no secondary market where they can be traded investors need to be sure they will not need their funds during the tenor of the investment; while the investment can be accessed before maturity by discounting it with the bank where it is made, this can only be done at a punitive discount rate which will take away most of the interest income that would otherwise have been made.
Other genres of financial institutions also offer fixed deposits, carrying relatively higher interest rates than the banks offer but accompanied by relatively higher risk too. Most non bank financial institutions use the fixed deposit rates offered by the banks as their benchmark and offer a premium, generally of between three and ten percent above the bank rates which means some of such institutions, particularly microfinance institutions, offer rates of more than 15 percent per annum above the treasury bill rate. While such rates are attractive, investors need to be very circumspect; many MFIs and savings and loans institutions are currently insolvent, some of them terminally so. This year the Bank of Ghana will work at weeding such institutions out like what it has already done with the banking industry. Until then though, investors would do well to insist on seeing recent financial statements of any NBFI under consideration to place a fixed deposit with to ensure it is solvent. The key ratios here are the capital adequacy ratio and the liquidity ratio and the investor is advised to seek advice from someone knowledgeable in interpreting the financial statements of such institutions.
Even within the NBFI sector there are wide variations with regards to both offered interest rates and accompanying risk. The basic rule of thumb is that the lowest rates (and accompanying risk) are offered by savings and loans companies, followed by investment taking specialized finance houses, and finally MFIs which tend to offer the highest interest rates but also carry the highest risk of default. However these vary from one institution to the other, depending on the quality of corporate governance and risk management employed.
Another alternative with regards to fixed income investments comes in the form of commercial paper and bankers acceptances. These are both short term debt issued by reputable (non-financial institution) corporations, through banks (and in some cases other genres of financial institution) which they use for working capital. The main difference between the two is that commercial paper debt is not guaranteed by the bank, or other financial institution issuing it to investors on behalf of the borrower, whereas bankers acceptances are guaranteed by the issuing financial institution. This means that BAs are safer than CPs and thus offer lower interest rates.
These types of investment are not open to the public. The issuing financial institution, having been given the mandate to raise the debt by the borrower, selects which of its customers it will offer the investment opportunity to, the selection based on what the issuing house knows about its customers access to investible short term funds and their willingness to take the implicit extra risk in order to earn higher returns than those offered by treasury instruments and fixed deposits. While the issuing house does its own due diligence on the borrower, since it does not want to lead its best quality customers into a bad investment, the investor is advised to do due diligence as well – on the borrower in the case of a CP and on the issuing financial institution in the case of a BA.
Currently CPs and BAs offer investors coupon rates of generally between 18 percent and 25 percent enabling the borrower to source working capital at well below the average bank lending rate and the investors to earn yields that are higher than those offered by fixed deposits and treasury bills.
Longer tenured investments are available in the form of corporate bonds. While these can be issued by both companies listed on the Ghana Stock Exchange and the Ghana Alternative Market (GAX), as well as those not listed, the former are much safer bets since they are subject to the regulations of the stock markets with regards to both good corporate governance practices and stringent financial reporting rules which enable investors to know how well their investment and the underlying financial institution that manages it are doing.
Here, GAX in particular offers a variety of investment options in the form of medium term corporate bonds offered by NBFIs to fund their lending activities. Currently, respectable financial institutions with strong track records of good financial performance, such as AFB, Bayport and Izwe Savings and Loans all have medium term bonds in issue which offer coupon rates of between 22 percent and 28 percent. Being traded on the stock market an investor can exit before maturity but since the secondary market for corporate bonds is not very liquid there is the real possibility that such sales would only be possible at a significant discount below the quoted bond price at the time of sale. Again this means investors need to be careful and preferably use professional advice from licensed investment advisors.
But for investors other than major institutional investors, who can afford to use the services of professional fund and asset managers licensed as such by the Securities and Exchange Commission, and thus can have them build specific investment portfolios that meet their peculiar needs and objectives with regards to yields, risk levels, tenors and liquidity, the best way to invest in fixed income securities is through a licensed fixed income collective investment scheme, be it a mutual fund or a unit trust. Instructively, for the investor there is no significant difference between the two; the only actual difference is in their respective organizational structures.
There are lots of collective investment schemes (CIVs) that invest strictly in fixed income instruments. However, since many others invest partly or wholly in equities or real estate, an investor seeking to invest strictly in fixed income instruments should find out which particular CIVs do this. SEC provides the information which can be obtained through its website.
Currently, fixed income CIVs offer annualized yields of between 15 percent and 26 percent. This wide variation is the result of the level of risk inherent in the investment portfolio used. For instance, a CIV that invests wholly in government securities is riskless but will only provide yields of between 15 percent and 17 percent generally, depending on the weighted tenors of the investments that make up the portfolio. CIVs that offer higher returns, of at least 20 percent are partly invested in corporate bonds, CPs and BAs which means they are riskier in that private issuers of debt securities carry default risk. However, CIVs are managed by investment professionals and instructively, none has gone under yet. Indeed, CIVs have the advantage of being liquid in that the fund managers are obliged under law to provide investors their invested monies within five working days of being asked to. There are a few however that bypass this regulation, with the approval of their investors. It is advisable for a potential investor to find out the specific rules governing investments made in a CIV being considered.
Even more importantly, a CIV or a fixed income investment portfolio designed and managed specifically for a particular investor has the crucial advantage of being diversified in that it would comprise of several types of instrument. This amounts to not putting all of ones eggs in one basket. While shorter tenured investments ensure liquidity for the investor, the longer tenured investment in the portfolio provide higher yields, as do instruments issued by private institutions, while the government securities in the portfolio reduce the overall risk levels the investor incurs.
Fund managers that offer dedicated portfolios to investors with large enough investible funds to deserve one, come in the form of either discretionary or non-discretionary portfolios. The former is a portfolio in which the fund manager chooses the structure of the portfolio and when and what to change at any given time, based on the overall investment objectives agreed with the investor. A non-discretionary portfolio is one in which the investor chooses the structure of the portfolio and the nature and timing of any changes to that structure, and the fund manager simply offers advice and executes the securities trading as instructed by the investor. Most licensed fund managers in Ghana offer both types.
Importantly, CIVs are registered as separate corporate entities from the fund managers that run them which reduces the risk to investors significantly since the collapse of the fund manager would still leave the investment fund itself intact.
No matter which type of fixed income instrument an investor chooses though, there is the possibility that interest rates, and therefore yields will rise this year or at least match last year’s performance. This is because the BoG has served notice that it has suspended its monetary easing – begun in late 2016 – in order to defend the cedi’s exchange rate. This has been necessitated by interest rate hikes in the United States as the Federal Reserve Bank ends the monetary easing implemented at the turn of the decade to simulate economic activity and thus head off the economic recession of that time brought about by the global financial crisis. Recent US interest rate hikes, which have been done at the same time that monetary easing in Ghana has resulted in falling domestic interest rates, have persuaded foreign portfolio investors to move out of cedi denominated investments into dollar denominated ones and this has put demand pressure on the available foreign exchange in Ghana thus generating the cedi’s depreciation.
The BoG has responded by actually tightening monetary policy a little on the quiet; although it has kept its benchmark Monetary Policy Rate at 17 percent since the middle of last year it has gradually increased the Ghana Reference Rate – used as a guide for the banks in setting their own base lending rates – by nearly 40 basis points since mid 2018. In 2018 treasury rates rose, especially at the short end of the market and since these serve as benchmarks for fixed deposit and other investment securities offered coupon rates, those have gone up too.
But with effect from this year, fund managers are no longer allowed to offer investment products that guarantee a specified level of returns. While this may be disappointing for investors in fixed income instruments, most of whom had become used to such guarantees, and indeed made their investment decisions largely on who was guaranteeing the highest, the new dispensation is more realistic in that those guarantees were more of marketing tools to attract investors than realistic promises; with the exception of coupon rates on treasury securities, even the fund managers themselves cannot be sure of just what precise level of returns they can generate over any given period of time and the more diversified the portfolio, the harder it is to forecast the yields that would be generated with any degree of accuracy.
During the second half of 2018 the GSE performed poorly, further making fixed income investments preferable to equities and so 2019 has started with bullish sentiments by fixed income investors. So for now, this is the best place to be although the fragility of the non bank financial intermediation industry means that investors are advised to seek professional advice from licensed investment advisors in choosing where to put their monies.
In part two of Where to Invest in 2019, which will be published on Friday, January 18, we will examine the outlook for investment in equities for the year.