Tuesday, November 30,
2021 / 09:34 AM / by Coronation Research / Header Image
Yes, it matters. As we pointed out several weeks ago, Fixed Income
mutual funds are winning market share from Money Market funds this year, thanks
to their superior yield. Yet some Fixed Income funds use mark-to-market
accounting to reach their Net Asset Value, while others use amortising. This
affects the returns that investors realise.
Last week, the exchange rate at the Investors and Exporters Window
(I&E Window) weakened by 0.16% to N415.07/US$1. Elsewhere, the Central Bank
of Nigeria’s (CBN) foreign exchange (FX) reserves declined by 0.25% – its
fourth consecutive weekly decline – to US$41.30bn as the CBN continues to ramp
up interventions in the FX market. Nevertheless, the level of FX reserves
remains high in historical terms and FX turnover in the official market has
been rising recently. Now that the CBN has brought more liquidity into the
official FX markets, we may see continued stability and possibly a further
easing of pressure in the parallel market.
Last week, activity in the Federal Government of Nigeria (FGN) bond
secondary market was bearish. Investor focus was on the T-bill Primary Market
Auction (PMA) and the market witnessed dominant selling pressure at the
mid-segment of the curve. As a result, the average benchmark yield for bonds
rose by 5bps to 11.41%. On benchmark notes, the yields of the 7-year (+22bps to
11.98%) and 10-year (+13bps to 12.29%) bonds expanded, while the yield on the
3-year bond (-9bps to 9.35%) declined. However, we reiterate our expectation
that a future rise in bond yields is unlikely to be sharp as the monetary
authorities appear content with recent economic and monetary outcomes, having
left the Monetary Policy Rate (MPR) unchanged at 11.50% last week.
Trading in the Treasury Bill (T-Bill) secondary market closed
bullish, and this was evidenced by a further decline in the stop-rate of the
364-day bill at the auction, coupled with market participants seeking to cover
unmet bids. The average benchmark yield for T-bills fell by 25bps to 4.85%. The
annualised yield on a 321-day T-bill fell by 1bp to 6.56%. At the T-bill PMA,
the DMO allotted N215.73bn (US$519.82m) worth of bills across all tenors. The
stop rate on the 364-day bill dropped by 61bps to 5.89% (annualised yield,
6.26%), while the rates on the 91-day (2.50%) and 182-day (3.50%) remained
unchanged. Demand was strong, with a total subscription of N416.27bn, implying
a bid-to-offer ratio of 3.51x (versus an average of 3.07x at the last four
auctions). Our sense is that the market for T-bills remains liquid and this is
likely to continue. Elsewhere, the average yield for OMO bills rose slightly by
2bps to 5.50%, with the yield on a 312-day OMO bill rising by 22bps to 6.33%.
Last week, the price of Brent fell by 7.82%, the highest weekly
decline since 20 August 2021, to settle at US$72.72/bbl, its lowest level since
27 August 2021. Consequently, Brent is up 40.39% year-to-date and has traded at
an average of US$70.59/bbl, 63.34% higher than the average of US$43.22/bbl in
2020. Oil prices continue to decline due to the combination of the US releasing
millions of barrels from its strategic reserves in coordination with other
large nations and concerns on the emergence of the new Omicron variant of the
Covid-19 virus, seen to have spread around the world on Sunday, with cases
found in the Netherlands, Denmark and Australia.
In the Organisation of the Petroleum Exporting Countries and its
allies (OPEC+) meeting to be held during the week, there is market speculation
that the cartel may takes measures to cut output. Elsewhere, Iran and world
powers are expected to resume talks on reviving the 2015 Iran nuclear deal in
Vienna today â€“ the outcome of which could set the tone for oil prices going
forward. Nonetheless, we maintain that the price of Brent oil is likely to
remain well above the US$60.00/bbl mark over the rest of the year and on into
the early part of next year. This is a comfortable position for the public
finances of Nigeria, in our view, though this depends on levels of domestic
production being high.
The NGX All-Share Index advanced by 0.25% last week to close at
43,308.29 points. Consequently, the year-to-date return improved to +7.54%.
Honeywell Flour Mills +16.81%, FBNH +3.90%, Airtel Africa +3.83% and Oando
+3.75% closed positive last week, while MRS -9.87%, International Breweries
-9.09%, Nigerian Breweries -8.82% and Seplat -3.63% dropped points. Across the
sector indices, the NGX Consumer Goods index declined by -2.00%, followed by
NGX Oil & Gas -0.87%, NGX Banking -0.29%, NGX Industrial -0.03%.
Conversely, the NGX Insurance index posted a gain of +3.56%. The Model Equity
Portfolio will be back next week.
Mutual Funds: Mark-to-Market vs Amortising
As we noted a few weeks ago, Fixed Income mutual funds have taken a
lot of market share away from Money Market mutual funds this year. The total
share of Assets Under Management (AUM) of all Money Market funds fell from
46.79% to 38.17% during the first nine months, while the market share of Fixed
Income funds rose from 27.64% to 31.66%. This is hardly surprising given the
superior percentage yields of FGN bonds (we calculate an average of 11.41%)
compared with the 1-year T-bill (6.56%). However, there is much more to this
story than yield.
Many investors probably do not realise that there are big
differences in what Money Market funds and Fixed Income funds invest in. Money
Market funds invest mainly in T-bills, Fixed Income funds invest mainly in FGN
bonds, but it would be wrong to think of an FGN bond as just a T-bill with a
duration of more than one year. A bond has a mark-to-market price and, as such,
Nigerian regulators demand that Fixed Income funds record their mark-to-market
price when presenting their Net Asset Value (NAV).
Some funds do this while others do not, as we described in
Coronation Research, Mutual Funds, Comparing Apples with Oranges, 11 May 2021.
Those that do not follow the mark-to-market rule typically amortise the value
of the bond over its life (like a T-bill). This means that the record of the
NAV of a fund is much smoother than if the fund manager reports according to
mark-to-market, especially during times of rapid interest rate changes.
Does the fund manager who uses the amortising method keep the fund
safe from swings in bond prices? Not at all. Take a hypothetical purchase of
units in such a fund at the beginning of January 2020 by a saver who decides to
redeem on 30 November of the same year. The mark-to-market move is enormous
(+66.0%), but the saver does not get the full benefit because the NAV only
reflects the amortised, not the market, value. What happens to the excess cash
realised by the fund on the unit holder’s sale? It is distributed among all the
If the same fund manager uses mark-to-market accounting, the NAV
moves in line with the market prices of the bonds held by the fund. The
hypothetical saver in our example would do much better but would lose if they
had bought units in November 2020 and sold in late May 2021, for example.
The chart we present here is for the Bloomberg Nigeria Local
Sovereign Index, an index of FGN bonds at market value. It illustrates what
could happen to the NAV of a Naira-denominated Fixed Income fund if it followed
the mark-tomarket principle. Its average duration is unusually long – 11.8
years – therefore, its volatility is much higher than most real-world Nigerian
Fixed Income funds, for which an average duration of four to five years is
Nigerian mutual funds will need to adopt market-to-market
accounting if they are to adopt Global Investment Performance Standards (GIPS),
which is a pre-requisite for them being able to attract international
institutional investment. These have begun to be adopted by the industry in
Nigeria. In time we believe that savers will understand that there is no hiding
from the market. Risk management is about evaluating market risk rather than
finding an accounting method that softens the edges.