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Monday, March 27, 2023

The Trillion-Naira Rotation That’s Endangering Your Nest Egg

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Money market securities are often considered a good place to invest funds that are needed in a shorter time period—usually one year or less.

Money market instruments include bankers’ acceptances, certificates of deposit and commercial paper.

Nigerian Pension Fund Administrators (PFAs) have however turned this sound finance 101 logic on its head, preferring to park some 16.4 percent of their assets under management (AUM) in short term money market securities, the latest data from the regulator PENCOM as at July 2021, shows.

That’s up from N1.04 trillion or 11.21 percent of AuM that PFAs invested in Money market securities just 2 years ago in July 2019.

The trillion-naira rotation should be a major issue of concern for the 9.4 million Nigerians who own a retirement savings account (RSA) managed by the domestic pension funds.

The exposure to money market securities is 2.4 times PFA investments in domestic equities, at a time of rising/ elevated inflation which is good for equities and bad for fixed income securities.

On a month on month basis, PENCOM data shows that PFAs are actually accelerating their exposure to money market instruments.

Between June 2021 and July 2021, PFAs expanded their holdings of money market instruments, while being underweight other asset classes.

For instance, AuM invested in money market instruments increased to N2.108 trillion in July 2021, from N1.736 trillion in June 2021.

Other asset classes however saw a decline in AuM.

These include investments in assets such as domestic shares which fell to N843.19 billion in July 2021 from N862.11 billion in June and FGN securities which dropped to N8.2 trillion in July from N8.47 trillion in June.

Suffice to say that the current state of affairs is unlikely to augur well for retirees in the near future.

Equities are a better way to protect a portfolio over the long term, particularly against an unexpected flare-up of inflation. Corporate earnings often grow faster when inflation is higher.

Meanwhile Inflation erodes the purchasing power of a bond’s future cash flows. Put simply, the higher the current rate of inflation and the higher the (expected) future rates of inflation, the higher the yields will rise across the yield curve, as investors will demand this higher yield to compensate for inflation risk.

Inflation also erodes the value of money. In an inflationary environment everything costs more. Nigeria’s inflation rose by 17.38 percent in July 2021.

If a ton of frozen chicken costs N1,200 this month and next month costs N1,800, inflation has cut the purchasing power of Nigerians by 50 percent.

One of the reasons why Pension Funds may be interested in buying bonds or money market securities is the reliability of future interest payments.

However, inflation eats into the purchasing power of every naira received from bond interest in the future.

Since those interest payments are now less valuable as inflation rises, the bond is less valuable. This causes the price of the bond to drop!

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