Picking investment products to hedge against inflation (1)

George Iwuagwu, passionate about financial literacy and development economics, is a seasoned investment analyst and wealth manager who has worked with some of the big names in the Asset Management industry, and currently Business Development Manager at UKdion Investment. He can be reached at george.iwuagwu2017@gmail.com; +2348039104910 (text only)

It is a given that every investor is driven by an objective, whether retail, HNI or institutional. This is the principle or need that steers their investment decision in a certain instrument, be it in traditional or non-traditional asset classes, tenure or risk exposure. As we experience groundbreaking innovative products and schemes amongst capital market operators, with investors’ needs becoming more advanced and even sophisticated, investment needs may change but you can still pin it down to three basic objectives: Safety, Income and Capital Growth.

As the topic of this piece suggests, investment objectives are only explained here to help the reader appreciate the below thought line. For every investor, one, two or even three of the said objectives drive their choice of a particular investment vehicle.

Safety:- As much as no investment is 100% safe, you can come very close to having a relatively safe one when investing in government backed or issued securities in a stable economic system. That is investments in federal government issued bonds, treasury bills and money market funds. Money market funds are included because they are statutorily required by Securities and Exchange Commission (SEC) to invest larger chunks of pooled funds in short tenured government securities. So, clients have to envision the collapse of the Nigerian government to worry about the safety of their monies. The federal government has since 1960 not defaulted on payment of debt, its liquidity has not been that bad it cannot pay the country’s debt.

Second is AAA rated large private sector companies. These also issue corporate bonds and other instruments through which they drive both long and short tenured financial needs. According to a recent capital market report, Nigeria’s five most valuable companies Nestle, BUA, MTN, Airtel and Dangote Cement, together are worth $36.1 billion, about N14.4 trillion in market value. Almost all of them have at one time or the other raised funds through the capital market by issuing bonds, commercial papers, etc. You also have to envision them collapsing to worry about your investments. It is also worthy of note that safety comes with a price, returns on very safe instruments are very low; comparing Nigeria’s T-bills to returns in commercial papers will give you a hint.

Income:- Investors who are income focused tend to invest in fixed income securities that return steady fixed and periodic income. People with income objectives are usually retirees, who desire to augment their monthly income with what they receive monthly to hedge against inflation. So, their objectives are usually income focused. They are willing to take a bit more risk to stay above inflation and maintain a standard of living or one unnoticeably lower than where they were in active service. Government and corporate bonds may be in the mix, and an income investor may go beyond the safest AAA-rated choices and will go longer than short-term CDs.

The ratings are assigned by a rating agency. Rating agencies are institutions that evaluate the financial stability of a company or government issuing the bond and other instruments. Bonds rated at A or AA are only slightly riskier than AAA Bonds but offer a higher rate of return. BBB-rated bonds carry a medium risk but more returns, it typically says the more the returns the more the risk.

There also is, to some extent, interest rate risk. That is, you could tie your money up in a bond that pays a 1% return, and then watch as inflation rises to 2%. You have just lost money in terms of real spending power.

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