Investing in FGN Bonds

What are bonds? Bonds are simply a term for loans that you give to the Federal Government, State Government, Companies etc.

Is it a document or what? It’s simply a piece of paper issued by the Borrower (e.g the Government) stating the amount borrowed from you, the tenor (no of years with which to repay), interest rate, and repayment period

Why me? Can’t they go to a bank to borrow money? You because you may have some money that you wish to save. You may say you have just N10k to save a month from your salary and wonder how that helps the government. Imagine that there are 1million people with N10k to save, that transcends to N10b already. Also have in mind that the money the banks actually lend are money deposited by you and I. So you and I are the major source of money for government, banks, corporations etc. That is why they tax us, pursue us to open accounts, and pressure us to buy their goods.

What’s in it for me? Bond issuers (borrowers like the government) typically attach a coupon to the Bonds. Coupon are basically interest rates attached to the Bonds issues. For example, the Government can issue a bond for say N10b, 10year bonds at a coupon of 6%pa. What they mean is that they want to borrow N10b from the public and are willing to pay 6% interest rate for it per annum for a period of 10years. Usually they pay you the principal amount at maturity meaning at the end of 10years and sometimes they can have the option to “call back” which basically means the can pay you the principal before the 10 year period. Bonds with “Call Back” are always clearly stated in the prospectus.So, in a nutshell if you borrow them N10k, you form part of many others who must have lent them as well. They pay you N600 per annum and pay you the N10k a the end of 10 years.

What? Just N600? Yes just N600. Well, you may think of it as low but the if you put that same amount in a Savings Account of bank you’d probably get N200 and stand the risk of loosing it if the bank collapses. Besides if it is N1m you invest then that’s N60k every year, N10m is N600k and N100m is N6m per annum.

Are you saying Government Can’t collapse? Well technically they can but it’s very unlikely. Even if they do, it’s if there is a war but then they must repay after the war is over. Government bonds are mostly secure and are guaranteed by the full faith and credit of the Government.

So I have to wait for 10years to get my money back? Off course not. The beauty of bonds is that you can exchange them just like shares. You can decide to sell your bond on the bond market if you want your money back.

Oh, so I put in N10k and get my N10k back plus interest? Yes if you decide to hold to maturity and wait for 10years. But if you wish to sell before then you can except that it could be worth more or less. Just like shares the value of bonds go up and down depending on economic factors. So, the bond you bought for N10k may be worth N11k or N9k when you are selling it. Just like shares, today it’s up tomorrow it may be low. But at maturity (the repayment day) the government or borrower must pay you the face value. The face value is the N10k you paid them. Movement in the market does not affect what the borrower pays you.

So are bonds really like shares then? Not exactly, whilst both are investment securities they are different in their nature. When you buy shares, you buy right to earn a dividend of a company. Meaning that you only get dividends when the company decided to pay you. For a Bond, the borrower or issuer (that’s is the Government or company) MUST pay you interest (coupon) a the stated date. In other words, owners of shares are equity holders, whilst owners of bonds are debt holders.

I have often heard of yields, what is that too? Well yields are basically interest on traded bonds. In my previous illustration I explained that the government pays you a coupon of 6%pa on your N10k bond. Since we understand that bonds are tradable, supposing the value was 9k at the time you sell the bond. It then means whomever buys it will earn N600 on the N9k he paid out. Thus his actual interest otherwise called yield is 600/9000 = 6.66%. So he gains an extra .66% and still gets to get another N1000 if he decides to wait till the maturity of the bond. They often say the yield of a bond moves in opposite direction to the value. Just as above, as the value dropped to N9k the yield increased to 6.66%.

That’s cheating me isn’t it? Nah not true. Remember, there is an opportunity cost you may incur if you do not sell. Imagine you had a business that will probably get you twice that amount if you sell. So instead of holding on just so it gets to 10k or higher, you sell and use the money for something more tangible. Also remember that you would have collected some interest as well. And then you can simply just hold on till maturity, it all depends on your opportunity cost.

Ok now I get it! How do I then invest? Bonds can be purchased either through the primary or secondary market.

The primary market is were you buy bonds that have just been offered by the seller like the Government (just like buying a public offer). The secondary market is where you buy tradable bonds that is, bonds from the bonds market (just like buying shares in the stock market). Bonds traded in the secondary market are usually done on the floor of the Nigerian Stock Exchange or Over the Counter (OTC) through the PDMM

Bonds sold in the primary or secondary market are bought through a PDMM(Primary Dealer Market Maker). PDMM are operators licensed to buy and sell bonds. Most of them are banks like Zenith, GTB, UBA, Diamond Bank to name a few. They also have discount houses like Kakawa Discount House, FSDH who sell as well. You get the application form from them, fill it, include your cheque in full for the amount you wish to invest. You can invest as much as you can, from N10k to N1b depending on your capabilities financially. But the minimum is N10k and multiple of N1k thereafter.

The bonds purchased are confirmed through issuance of depository or issuance of certificates. The depository is the CSCS (Central Security Clearing System) an online storage for securities such as shares and bonds.

How do I get my interest? Interest on Government Bonds are paid Semi annually.For example in June and December or in January and July. Payment is through issuance of cheques or warrants, similar to the dividend warrants you get for shares.

Also note that interest rates can be fixed or floating. Fixed means when they say they will pay you 6%pa then it is 6%pa you get till the end if the maturity. Floating means they may pay you an amount that is linked to a are that moves with the market. For example they might say Nibor 8% plus 2%. Meaning the rate is benchmarked o. The Nigerian Interbank Official Rate (Nibor) of 8% plus 2%. The Nibor is a rate that banks use to lend money to each other and it always changes in response to market conditions and is thus the floating rate.

Source: Nairaland

Half- Year Appraisal

July 1 marked the second half of this year. What were some of the goals you desired to accomplish this year? It’s time to assess your success rates so far. I cannot stress the importance of saving for rainy days. Especially for women who deal with major financial crisis if anything happens to the breadwinner. Ensure the habit of saving 70% of your monthly salary (not lower than 50%) consistently and continously. The power of compound interest works on whatever amount you are stashing away right now. For a minimal sum of N10,000 you can invest in mutual funds managed by ARM Investment (a subsidiary of GTB). Other mutual funds managed by BGL Securities and First Bank Capital require a minimum of N500,000. Whichever way the cookie crumbles, you need to cultivate the habit of regular savings.

I’m a lover of leisure travel, clothes, culinary pleasures and shoes. However, I have not allowed my love for these things to deter me from imbibing a saving culture. I usually have a financial goal for the year which reads thus ‘ In 2011, I will save ……. by year end and invest in the following financial vehicles’. That’s how far I go and once I’ve made this committment, I adhere to my plans and until I achieve this goal, then there’s no travelling or any other pleasurable thing I indulge it. However, once I cross the mark, I whip out my pleasure list to decide what i’m indulging in. Overall, it must also fit within my budget or else I forgo and settle for something affordable.

In appraising your financial situation, you need to take into consideration how much you need to kick your saving gear in the right direction. Once you have a plan, stick to it and accomplish. In subsequent posts, i’ll be giving out information on the financial vehicles you can invest in.

Have a great year (2nd Half) ahead.

Investing in turbulent times

Hey, don’t go thinking I know all the answers cos I don’t. I am actually trying to discover what everyone is investing in amidst the global financial crisis. I spoke with a friend of mine yesterday and she suggested real estate. My grouse with buying land in Nigeria is the issue of  “Omo o nile” and attendant dubious charges. I would rather buy a detached three bedroom bungalow, within the range of N5mn – N6mn (which is dependent on whether I can access mortgage facilties), located in Lagos. Since I don’t have such huge funds right now, I have to think of something else.

For the past one month, I have been trying to scout for other alternative investment options (long-term), and someone had suggested ARM Investment. Please note that I did not include the link to the website. I’d rather not cos from my own point of view, either they are yet to engage the services of a social media strategist, or someone is simply not doing their job. I filled in the forms a month ago and I am yet to be contacted by a Wealth Advisor. What is the essence of setting up a website if there’s no one capable of attending to visitor’s enquiries. I also tried calling the numbers stated on the websites and unfortunately, none seems to be working.

My question today is: If you have some funds sitting idle in your savings account, where would you invest it?

How to Buy and Sell Shares

You can purchase shares in some mutual funds by contacting the fund directly. Other mutual fund shares are sold mainly through brokers, banks, financial planners, or insurance agents. All mutual funds will redeem (buy back) your shares on any business day and must send you the payment within seven days.

The easiest way to determine the value of your shares is to call the fund’s number or visit its website. The financial pages of major newspapers sometimes print the NAVs for various mutual funds. When you buy shares, you pay the current NAV per share plus any fee the fund assesses at the time of purchase, such as a purchase sales load or other type of purchase fee. When you sell your shares, the fund will pay you the NAV minus any fee the fund assesses at the time of redemption, such as a deferred (or back-end) sales load or redemption fee. A fund’s NAV goes up or down daily as its holdings change in value.

Exchanging Shares A “family of funds” is a group of mutual funds that share administrative and distribution systems. Each fund in a family may have different investment objectives and follow different strategies.

Some funds offer exchange privileges within a family of funds, allowing shareholders to transfer their holdings from one fund to another as their investment goals or tolerance for risk change. While some funds impose fees for exchanges, most funds typically do not. To learn more about a fund’s exchange policies, call the fund’s number, visit its website, or read the “shareholder information” section of the prospectus.

Bear in mind that exchanges have tax consequences. Even if the fund doesn’t charge you for the transfer, you’ll be liable for any capital gain on the sale of your old shares — or, depending on the circumstances, eligible to take a capital loss. We’ll discuss taxes in further detail below.

How Funds Can Earn Money for You

You can earn money from your investment in three ways:

  1. Dividend Payments — A fund may earn income in the form of dividends and interest on the securities in its portfolio. The fund then pays its shareholders nearly all of the income (minus disclosed expenses) it has earned in the form of dividends.
  2. Capital Gains Distributions — The price of the securities a fund owns may increase. When a fund sells a security that has increased in price, the fund has a capital gain. At the end of the year, most funds distribute these capital gains (minus any capital losses) to investors.
  3. Increased NAV — If the market value of a fund’s portfolio increases after deduction of expenses and liabilities, then the value (NAV) of the fund and its shares increases. The higher NAV reflects the higher value of your investment.

With respect to dividend payments and capital gains distributions, funds usually will give you a choice: the fund can send you a check or other form of payment, or you can have your dividends or distributions reinvested in the fund to buy more shares (often without paying an additional sales load).

Factors to Consider

Thinking about your long-term investment strategies and tolerance for risk can help you decide what type of fund is best suited for you. But you should also consider the effect that fees and taxes will have on your returns over time.

Degrees of Risk

All funds carry some level of risk. You may lose some or all of the money you invest — your principal — because the securities held by a fund go up and down in value. Dividend or interest payments may also fluctuate as market conditions change.

Before you invest, be sure to read a fund’s prospectus and shareholder reports to learn about its investment strategy and the potential risks. Funds with higher rates of return may take risks that are beyond your comfort level and are inconsistent with your financial goals.

A Word About Derivatives Derivatives are financial instruments whose performance is derived, at least in part, from the performance of an underlying asset, security, or index. Even small market movements can dramatically affect their value, sometimes in unpredictable ways.

There are many types of derivatives with many different uses. A fund’s prospectus will disclose whether and how it may use derivatives. You may also want to call a fund and ask how it uses these instruments.

Fees and Expenses

As with any business, running a mutual fund involves costs — including shareholder transaction costs, investment advisory fees, and marketing and distribution expenses. Funds pass along these costs to investors by imposing fees and expenses. It is important that you understand these charges because they lower your returns.

Some funds impose “shareholder fees” directly on investors whenever they buy or sell shares. In addition, every fund has regular, recurring, fund-wide “operating expenses.” Funds typically pay their operating expenses out of fund assets — which means that investors indirectly pay these costs.

SEC rules require funds to disclose both shareholder fees and operating expenses in a “fee table” near the front of a fund’s prospectus. The lists below will help you decode the fee table and understand the various fees a fund may impose:

Shareholder Fees

  • Sales Charge (Load) on Purchases — the amount you pay when you buy shares in a mutual fund. Also known as a “front-end load,” this fee typically goes to the brokers that sell the fund’s shares. Front-end loads reduce the amount of your investment. For example, let’s say you have N100,000 and want to invest it in a mutual fund with a 5% front-end load. The N5,000 sales load you must pay comes off the top, and the remaining N95,000 will be invested in the fund. According to the rules, a front-end load cannot be higher than 8.5% of your investment.
  • Purchase Fee — another type of fee that some funds charge their shareholders when they buy shares. Unlike a front-end sales load, a purchase fee is paid to the fund (not to a broker) and is typically imposed to defray some of the fund’s costs associated with the purchase.
  • Deferred Sales Charge (Load) — a fee you pay when you sell your shares. Also known as a “back-end load,” this fee typically goes to the brokers that sell the fund’s shares. The most common type of back-end sales load is the “contingent deferred sales load” (also known as a “CDSC” or “CDSL”). The amount of this type of load will depend on how long the investor holds his or her shares and typically decreases to zero if the investor holds his or her shares long enough.
  • Redemption Fee — another type of fee that some funds charge their shareholders when they sell or redeem shares. Unlike a deferred sales load, a redemption fee is paid to the fund (not to a broker) and is typically used to defray fund costs associated with a shareholder’s redemption.
  • Exchange Fee — a fee that some funds impose on shareholders if they exchange (transfer) to another fund within the same fund group or “family of funds.”
  • Account fee — a fee that some funds separately impose on investors in connection with the maintenance of their accounts. For example, some funds impose an account maintenance fee on accounts whose value is less than a certain dollar amount.

Annual Fund Operating Expenses

  • Management Fees — fees that are paid out of fund assets to the fund’s investment adviser for investment portfolio management, any other management fees payable to the fund’s investment adviser or its affiliates, and administrative fees payable to the investment adviser that are not included in the “Other Expenses” category (discussed below).
  • Distribution [and/or Service] Fees (“12b-1” Fees) — fees paid by the fund out of fund assets to cover the costs of marketing and selling fund shares and sometimes to cover the costs of providing shareholder services. “Distribution fees” include fees to compensate brokers and others who sell fund shares and to pay for advertising, the printing and mailing of prospectuses to new investors, and the printing and mailing of sales literature. “Shareholder Service Fees” are fees paid to persons to respond to investor inquiries and provide investors with information about their investments.
  • Other Expenses — expenses not included under “Management Fees” or “Distribution or Service (12b-1) Fees,” such as any shareholder service expenses that are not already included in the 12b-1 fees, custodial expenses, legal and accounting expenses, transfer agent expenses, and other administrative expenses.
  • Total Annual Fund Operating Expenses (“Expense Ratio”) — the line of the fee table that represents the total of all of a fund’s annual fund operating expenses, expressed as a percentage of the fund’s average net assets. Looking at the expense ratio can help you make comparisons among funds.
A Word About “No-Load” Funds Some funds call themselves “no-load.” As the name implies, this means that the fund does not charge any type of sales load. But, as discussed above, not every type of shareholder fee is a “sales load.” A no-load fund may charge fees that are not sales loads, such as purchase fees, redemption fees, exchange fees, and account fees. No-load funds will also have operating expenses.

Be sure to review carefully the fee tables of any funds you’re considering, including no-load funds. Even small differences in fees can translate into large differences in returns over time. For example, if you invested N10,000 in a fund that produced a 10% annual return before expenses and had annual operating expenses of 1.5%, then after 20 years you would have roughly N49,725. But if the fund had expenses of only 0.5%, then you would end up with N60,858 — an 18% difference.

How Mutual Funds Work

A mutual fund is a company that pools money from many investors and invests the money in stocks, bonds, short-term money-market instruments, other securities or assets, or some combination of these investments. The combined holdings the mutual fund owns are known as its portfolio. Each share represents an investor’s proportionate ownership of the fund’s holdings and the income those holdings generate.

Some of the traditional, distinguishing characteristics of mutual funds include the following:

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Investors purchase mutual fund shares from the fund itself (or through a broker for the fund) instead of from other investors on a secondary market, such as the Nigerian Stock Exchange.

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The price that investors pay for mutual fund shares is the funds per share net asset value (NAV) plus any shareholder fees that the fund imposes at the time of purchase (such as sales loads).

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Mutual fund shares are “redeemable,” meaning investors can sell their shares back to the fund (or to a broker acting for the fund).

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Mutual funds generally create and sell new shares to accommodate new investors. In other words, they sell their shares on a continuous basis, although some funds stop selling when, for example, they become too large.

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The investment portfolios of mutual funds typically are managed by separate entities known as “investment advisers” that are registered with the SEC.

When it comes to investing in mutual funds, investors have literally thousands of choices. Before you invest in any given fund, decide whether the investment strategy and risks of the fund are a good fit for you. The first step to successful investing is figuring out your financial goals and risk tolerance — either on your own or with the help of a financial professional. Once you know what you’re saving for, when you’ll need the money, and how much risk you can tolerate, you can more easily narrow your choices.

Most mutual funds fall into one of three main categories — money market funds, bond funds (also called “fixed income” funds), and stock funds (also called “equity” funds). Each type has different features and different risks and rewards. Generally, the higher the potential return, the higher the risk of loss.

Money Market Funds

Money market funds have relatively low risks, compared to other mutual funds (and most other investments). By law, they can invest in only certain high-quality, short-term investments issued by the Nigerian government, private corporations, and state and local governments. Money market funds try to keep their net asset value (NAV) — which represents the value of one share in a fund — at a stable N1.00 per share. But the NAV may fall below N1.00 if the fund’s investments perform poorly. Investor losses have been rare, but they are possible.

Money market funds pay dividends that generally reflect short-term interest rates, and historically the returns for money market funds have been lower than for either bond or stock funds. That’s why “inflation risk” — the risk that inflation will outpace and erode investment returns over time — can be a potential concern for investors in money market funds.

Bond Funds

Bond funds generally have higher risks than money market funds, largely because they typically pursue strategies aimed at producing higher yields. Unlike money market funds, the SEC’s rules do not restrict bond funds to high-quality or short-term investments. Because there are many different types of bonds, bond funds can vary dramatically in their risks and rewards. Some of the risks associated with bond funds include:

Credit Risk — the possibility those companies or other issuers whose bonds are owned by the fund may fail to pay their debts (including the debt owed to holders of their bonds). Credit risk is less of a factor for bond funds that invest in insured bonds or Nigerian Treasury bonds. By contrast, those that invest in the bonds of companies with poor credit ratings generally will be subject to higher risk.

Interest Rate Risk — the risk that the market value of the bonds will go down when interest rates go up. Because of this, you can lose money in any bond fund, including those that invest only in insured bonds or Treasury bonds. Funds that invest in longer-term bonds tend to have higher interest rate risk.

Prepayment Risk — the chance that a bond will be paid off early. For example, if interest rates fall, a bond issuer may decide to pay off (or “retire”) its debt and issue new bonds that pay a lower rate. When this happens, the fund may not be able to reinvest the proceeds in an investment with as high a return or yield.

Stock Funds

Although a stock fund’s value can rise and fall quickly (and dramatically) over the short term, historically stocks have performed better over the long term than other types of investments — including corporate bonds, government bonds, and treasury securities.

Overall “market risk” poses the greatest potential danger for investors in stocks funds. Stock prices can fluctuate for a broad range of reasons — such as the overall strength of the economy or demand for particular products or services.

Not all stock funds are the same. For example:

· Growth funds focus on stocks that may not pay a regular dividend but have the potential for large capital gains.

· Income funds invest in stocks that pay regular dividends.

· Sector funds may specialize in a particular industry segment, such as technology or consumer products stocks.

Investing in Mutual Funds

Part of my goals for the month of September is to save at least half a million naira towards recent investment towards mutual funds. However, recent events have overtaken this goal. I recently invested a tidy sum in a private placement stock market ace analyst “Abayomi Obabolujo”recommended while I’m also purchasing a bit of Dangote Flour. What this means is that I may not be able to invest half a million naira. I may end up investing with N350,000.

I have been thinking about investing in mutual funds recently to diversify my portfolio and also look at the possibility of investing in the money market to ensure a steady stream of income in the long run. So when IBTC recently came to the money market with “the Guaranteed Fund” I knew it was time to commence an investment goal toward the fund. If you’ve been considering investing in mutual funds, these are some of the things you should know.

Some of my goals for investing in mutual funds are retirement and real estate investment for the future. Mutual funds can offer the advantages of diversification and professional management. But, as with other investment choices, investing in mutual funds involves risk. And fees and taxes will diminish a fund’s returns. It pays to understand both the upsides and the downsides of mutual fund investing and how to choose products that match your goals and tolerance for risk.

Key Points to Remember

  • Mutual funds are not guaranteed or insured by the CBN, NDIC or any other government agency — even if you buy through a bank and the fund carries the bank’s name. You can lose money investing in mutual funds.
  • Past performance is not a reliable indicator of future performance. So don’t be dazzled by last year’s high returns. But past performance can help you assess a fund’s volatility over time.
  • All mutual funds have costs that lower your investment returns. Shop around, and use an average Naira margin to compare many of the costs of owning different funds before you buy.