CBN rate hikes boost bonds’ allure for pension funds

Pension fund administrators (PFAs) look set to ramp up their investments in bonds as recent interest rate hikes have raised the prospect of higher returns.
The Central Bank of Nigeria (CBN) increased its monetary policy rate (MPR), also known as the benchmark interest rate, for the second straight month last week by 200 basis points (bps) to 24.75 percent after a 400bps hike in February.

Higher interest rates may lead to increased demand for fixed-income instruments, including government bonds, with PFAs adjusting their asset allocation strategies, industry analysts have said.

As of February 2024, more than 70 percent of pension fund assets were invested in bonds and about 10 percent in money market instruments, according to Michael Oyebola, an investment expert in one of the PFAs and analyst at Moneycounsellors.
He said the recent hikes in MPR by the CBN would mean higher fixed income returns because when interest rates rise, the yields on fixed-income investments also increase.
This then leads to higher returns for pension funds holding the assets. However, whilst this leads to higher yields for new bonds, existing bonds with lower yields become less attractive. As a result, the prices of existing bonds in the pension funds’ portfolio may decrease,” he said.
He, however, noted that as the demographics of pension industry assets are skewed to the younger generation, with more than 75 percent in the 19 to 39 age range and another almost 20 percent in the 40 to 49 age range, most PFAs hold bonds to maturity.

Chika Onwunali, managing consultant at Premium Debate, a platform that tracks insurance and pensions, said the rate hikes would increase income growth for money market instruments, adding that the value of equity investments may be impacted by changes in interest rates and market sentiment.

He said the long-term investors may benefit from the higher rates if they have a diversified portfolio.

“There certainly will be increased allocation to more bonds and treasury bills” by PFAs, he said.
He pointed out that the 364-day Nigerian Treasury Bill (NTB) auction last week closed at 21.124 percent and was oversubscribed by 1,750 percent, while the 182-day NTB was oversubscribed by 3,730 percent at a stop rate of 17 percent.

Onwunali said the result of the auction showed increased activity at the short-duration end of the fixed-income spectrum to mitigate potential further interest rate hikes.
Expectation is also that they (PFAs) will possibly look to diversify into alternative investments such as real estate (if any viable opportunities present themselves), as well as infrastructure, which is good for the recently launched presidential initiative,” he said.

Oyebola, the investment expert, also expects PFAs to adjust their investment strategies accordingly to optimise returns while managing risks.

On what risk protection measures the PFAs should adopt, he said: “PFAs should allocate assets across a mix of equities, fixed income securities, real estate, and alternative investments to spread risk.”
He said: “Another will be asset liability management (ALM). A PFA should implement an effective ALM strategy. This involves matching the duration and cash flow requirements of pension liabilities with the duration and liquidity profile of pension assets.

“I will expect PFAs to keep conducting regular risk assessments and monitoring each fund’s – fund I, II, III, IV, V, VI (A), VI (R) – exposure to various risks, including market risk, credit risk, liquidity risk, and operational risk. In all this, I will expect the PFAs to continue to ensure regulatory compliance, adhering to regulatory guidelines and best investment practices.”

Oguche Agudah, chief executive officer of Pension Fund Operators Association of Nigeria (PenOp), while analysing key drivers of pension fund assets growth, said domestic ordinary shares, foreign ordinary shares, government debt securities, corporate debt and cash held by pension funds accounted for almost 93 percent of the growth of N1.75 trillion recorded last year.

Agudah said the value of ordinary shares held by pension funds surged by over N360 billion between December and January this year. “This was driven by a bull run in the NGX as the All Share Index reached another milestone. Further highlighting this is the increase in allocation to domestic listed equities by the pension funds from 8.56 percent to 9.89 percent of their total assets.”

“Foreign ordinary shares also played a role in the surge. The devaluation of the naira meant the revaluation of foreign assets upwards, leading to a growth in value of foreign assets held by Closed Pension Funds Administrators by over N118 billion.”
Aguda said fixed income securities also played a significant part.

He said: “Both federal government securities and corporate debt securities increased by N219 billion and N291 billion respectively. This growth in asset value is as a result of a push by the Nigerian government to mop up liquidity, offering high yields on government securities as it seeks to combat inflation.

“In summary, growth was being driven by investment performance as pension funds take advantage of the high yield regime offered by the central bank and also the impressive performance of the local stock exchange and the depreciation in the value of the naira versus the dollar.”


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