The recent global bond selloff is highlighting a risk that Nigerian investors often overlook when buying fixed-income investments. This risk arises when interest payments remain unchanged, but the amount an investor can recover by selling the investment falls. Major government bond markets are experiencing their worst month in years, with US two-year Treasury yields rising almost 0.6 percentage points in September. This development has significant implications for Nigerian investors holding dollar bonds or funds that invest in them.
A bond is essentially a loan to a government or company, with the borrower promising specified interest payments and repayment of the bond's face value at maturity. However, investors can buy and sell this loan before repayment falls due, and its market price changes. When comparable investments offer higher returns, buyers become less willing to pay the previous price for an older bond offering lower interest, causing its price to fall. This inverse relationship between bond prices and interest rates is a crucial concept for investors to understand.
For Nigerian investors, particularly those holding dollar bonds or funds that invest in them, the practical concern is what happens if they need their money before the investment has had time to recover. If an investor buys a bond for $1,000 and later sells it for $930, the $70 price loss must be counted alongside any interest received. Regular payments alone do not establish that the investment made money. This risk is especially relevant for savers who are putting aside dollars for specific expenses, such as school fees.
The situation is more complex for investors who buy units in a bond fund, which gives them exposure to a portfolio rather than ownership of one bond with a personal repayment date. If the market value of the underlying bonds falls, the fund's value can also fall. Funds holding longer-maturity bonds generally face greater interest-rate risk than otherwise comparable funds holding shorter maturities. This creates a timing problem for Nigerian savers, as the bill may arrive while the investment is worth less than expected.
It is essential for Nigerian investors to distinguish between the income earned from their investments and the capital they may lose. Holding an asset in dollars does not, by itself, preserve its dollar value. Investors need to take a closer look at their investments, checking what the fund owns, how much its value can fluctuate, what fees apply on withdrawal, and whether its advertised return includes changes in investment value or only income.
The current market situation, with higher yields improving the opportunity for new buyers, can also accompany a lower selling price for existing holders. The return that counts is the income received together with what the investment is worth when the money is needed. Nigerian investors must be aware of these dynamics to make informed decisions about their investments.
In conclusion, the global bond selloff is exposing a risk that Nigerian investors need to consider when buying fixed-income investments. By understanding the relationship between bond prices and interest rates, and carefully evaluating their investments, Nigerian investors can make more informed decisions and manage their risks effectively.
Key points
- Nigerian investors need to distinguish income earned from capital lost.
- Fixed interest payments do not protect a bond's resale price.
- Higher yields can improve the opportunity for new buyers but accompany a lower selling price for existing holders.
