Bonds the alternative investment to stocks

August 27, 2008
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, NAIROBI, August 13- Many investors are ignorant and sometimes unaware of the other investment vehicles existing at the capital markets.  At the same time most investors seem too much inclined to stocks that only a few of them are conversant with.

Apart from stocks, an investor could also put his money in bonds. These are medium to long term Government securities sold by the Central Bank of Kenya on behalf of Treasury. An investor earns a return during the period of the security and repayment of the face value is made on maturity date.

According to Perminus Wainaina, a financial and investment adviser at Concept Advisory Services, a bond is a debt to a company or government by investors.

He explains that when an investor purchases a bond, he is lending out his money to a company or government. In return, they agree to give him interest on his money and eventually pay back the amount he lent out.

The main attraction of bonds is their relative safety. If an investor is buying bonds from a stable government, one’s investment is virtually guaranteed, or risk-free. The safety and stability, however, comes at a cost. “Because there is little risk, there is little potential return,” Wainaina explains.

As a result, the rate of return on bonds is generally lower than other securities.

However according to James Murigu the Managing Director of Suntra Investment Bank, you cannot compare bonds’ returns to an investor who decides to let his money lie in a bank account.

While a commercial bank will mostly peg the return at 1%, a 20 year government bond offers a 14.7% return per annum.

There are several types of bonds; locally the most common ones are corporate and government bonds. The latter are initially offered by the government, while corporate bonds are issued by companies borrowing funds from the public.

Murigu notes that one can invest in newly issued bonds or buy the available ones such as the already listed Barclays Bank bond.

Pricing of bonds is dynamic and requires continuous advice by investment professionals. At the Nairobi Stock Exchange (NSE), bonds are traded in denominations of a minimum of Sh50,000 (government bonds).

The minimum size of investment for corporate bonds varies.

For instance, an investor will require a minimum of Sh100, 000 to invest in the Barclays bond.

Bonds are offered at a face value denominated in hundreds and at an interest rate (coupon rate) that is payable quarterly, semi-annually or annually.
Stocks versus bonds

Murigu laments over the low up take of bonds that the market continues to witness.

While bonds are also traded everyday, statistics indicate that less than 5% of investors invest in bonds.

“There is a need to enlighten investors about diversification,” he explains. He encourages investors to completely diversify their portfolio into the market through buying fixed incomes securities as well as equities.

Wainaina notes that when you purchase stocks, or equities, you become a part owner of the business. This entitles an investor to vote at the shareholders’ meeting, allowing one to receive any profits that the company allocates to its owners; well known as dividends.

On the other hand while bonds provide a steady stream of income, stocks are volatile. That is, they fluctuate in value on a daily basis meaning that they can give both growth and debt. When you buy a stock, you are not guaranteed anything. Many stocks don’t even pay dividends, in which case, the only way that you can make money is if the stock increases in value – which might not happen.

Stocks provide relatively high potential returns. “Of course, there is a price for this potential: you must assume the risk of losing some or all of your investment,” Wainaina adds.

Murigu however notes that in a stable economy bonds remain more favorable although a rising inflation rate leaves an investor stuck to the initial lower rate.

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