Corporate Bonds: Slow But Sure Keys to Wealth

Published on 25th September 2007

The Bull Run at the Nairobi Stock Exchange has over the recent years attracted several new investors to the bourse. Both local and foreign investors, including Kenyans in the Diaspora, have participated in the several IPOs, rights issues and stock splits that have made the NSE vibrant. Investors have been too keen on the performance of the equities segment of the market that they have literaly forgotten about the bonds market.

Recently, Barclays bank and KenGen announced their plan to raise Ksh.3 billion and Ksh.90 billion respectively by issuing corporate bonds. This attempt will be the second time that Barclays is trying to apply for a bonds issue. The first attempt was thwarted by the Capital Market Authority (CMA) on the grounds that it would cause a liquidity crunch in the market. With improved economic growth in the country and increase in cash flow in banks, the bonds issue has come at the right time. The Government is encouraging banks to come up with innovative ways of expanding their services in the market. A bond programme is one of them.

But do investors understand how to invest in bonds? Many of them are used to dealing in stocks which form the biggest and vibrant part of the NSE. The bonds section is regarded to have a low rate of return on investment compared to the equities segment. It is thus ignored or simply misunderstood, especially during a Bull Run. It takes a bear run for investors to appreciate the value of the bonds market. Bonds usually have a fixed rate of return on the initial investment, with periodic interest payments, mostly quarterly or semi-annually. As opposed to shares, when an investor buys a corporate bond he becomes a lender to the company that issued it, rather than the owner. Bonds usually provide a higher interest rate than banks.

Despite the low appeal elicited by bonds, daily turnover is usually in millions of shillings.  This may be attributed to the fact that to participate in a bond issue, an investor has to buy a minimum value of Ksh.100,000 and there after a multiple of the same.  This locks out a lot of small retail investors who usually capitalize on small short term speculative buys and sells in the equities segment of NSE. For serious investors with a long term vision, the bonds market offers a lucrative avenue to diversify their investments and mitigate against negative changes in the equity market.

Current corporate bonds on the NSE include PTA Bank, Shelter Afrique and Faulu Kenya Ltd. Before buying a corporate bond, an investor should carefully consider the financial stability of the issuing company. The more stable the company, the more likely your investment will be paid back. A bond that matures in one year is less risky than a 15 year bond.  

Bond Strategies

When investing in bonds, one can either choose to hold the bond to maturity or sell it before maturity. Most popular corporate bonds in Kenya are the floating rate kind; they are pegged on the movement of the 91 days treasury bills rate.  However if the coupon is fixed, the return per income period is constant just like the fixed treasury bonds.

Strategy 1: Buying and holding

Take an example of an investor who pays Ksh. 1 million for a five year bond with a 7% interest rate. Every year, he will earn Ksh.70,000 in interest. At the end of five years, he will have earned Ksh350,000 above what he invested. At the end of the five year period (maturity), he will be refunded the initial investment of Ksh.1 million.

Strategy 2: Buying then Selling

Suppose the investor in strategy 1 decided to sell his bond after a year. He will have received his first year’s interest of Ksh.70,000. Having bought a bond with a floating rate, what he gets from the sale will depend on the market rate at that time. Bonds normally have an inverse relation with the market rate. If the interest rate falls he will gain more on selling before maturity and if interest rates rise he loses. 

Depending on an investor’s objective of investing in corporate bonds, one can choose the strategy that suits him best. Corporate bonds guarantee a steady and predictable return. In the long run, stocks  outperform bonds but at certain times of the economic cycle, bonds out outperform stocks. It’s common for stocks to sometimes lose 20% or more in a year. For bonds however, it is always an upwards trend- slow but sure.

This article has been read 2,541 times