Which Is The Fairest Investment Asset Of Them All? – October 11, 2018

Posted by sigpe2017

Which Is The Fairest Investment Asset Of Them All?

In a reverse from 2017 when Nigerian stocks (or equities) rallied 42 percent, the equity bourse has had a torrid time in 2018 and is currently 20 per cent off its January peak which roughly fits the definition of a market correction. Naturally, local investor sentiment towards the equity market has turned sour amid recent increases in yields on fixed income instruments. The aversion to equities risk comes despite the dominance of fixed income instruments in domestic investment portfolios which should limit the impact of equity downturns on overall portfolio returns. As at the end of June 2018, data from the Securities and Exchange Commission (SEC) show that fixed income mutual funds accounted for 84 percent of funds under collective investment schemes which stood at NGN607billion[1]. In a similar vein, data from the National Pension Commission (PenCom) places the share of fixed income instruments of total pension assets (NGN8trillion) at 86 percent at the end of May. From the data, it appears that Nigerian investors have long voted with their wallets in favour of fixed income instruments. But is this necessarily a wise choice?

Globally, equities remain the primus inter pares

In investment parlance, the phrase stock beat bonds is a time honoured maxim in any tour across the universe of asset classes across different financial markets. Study after study, country after country, over long horizons, the evidence is clear: holding stocks has proven to be a winner over every other asset class and inflation. The rationale is straightforward: equities reflect residual claims on the profits of private businesses involved in the production of goods and services in an economy. The decision to invest in a business includes the element of risk and in a growing economy, the growth rate of corporate profits must be rising at a rate more than the returns of the do-nothing alternative i.e. putting money in a risk-free government securities. Putting this theory to data across 23 countries over the last 118years, empirical research has shown that equities have delivered an annualized return premium, relative to Bonds and Treasury bills, of around 320bps and 430bps respectively across all markets.


Figure 1: Annualized real returns on asset classes 1900-2017 (%)

Source: Credit Suisse Global Investment Returns Yearbook 2018

Given the outperformance of equities, the asset class remains the mainstay of investment portfolios across the globe. At the end of 2017, around 46% of global pension fund portfolios estimated at USD41trillion was parked in equity instruments with fixed income accounting for 21% and alternative investments at 25%[2].

Taking A Longer View, Equities Deliver Best-In-Class Returns Even In Nigeria

In contrast with advanced economies that possess a long history of investing in financial assets, dating back to the 1900s, capital markets in Nigeria are a more recent phenomenon with the predecessor of the present-day Nigerian Stock Exchange commencing activities only in 1961 with 19 securities: 3 stocks, 6 FGN Bonds and 10 industrial loans. Furthermore, data is patchy, and the fixed income market has been illiquid for large parts of Nigeria’s history with redemption only via the CBN. As a result, we start our analysis from 1999, which is a regime change as it marks a transition away from the era of military rule to the current democratic dispensation. Consistent with the global norms, we find that domestic equities (as proxied by the returns on the NSEASI) have delivered 200bps real return and outperformed the average yield on both short-dated and long-term government securities between 1999-2017. The findings show that despite three rounds of steep market corrections in 2008-9, 2010-11 and 2015-16, we find that Nigerian equities still outperform fixed income instruments on an annualized basis over the period.

Figure 2: Annualized returns on asset classes 1999-2017 (%)

Source: CBN, NSE, FMDQ, Sigma Research

To dispel accusations of data mining, our findings remain resilient when we stretch the analysis further back to 1985, we find that Nigerian equities generate real returns in excess of inflation and the USDNGN (around 200bps) with annualized returns of 22%. Clearly over long horizons, we find that equity investments generate the best returns so why do Nigerian investment portfolios underweight equities presently?

Recent Underperformance Is Taking The Short View

Looking through the data again, we find as with global patterns, which were adversely impacted by the global financial crises in 2008-9, that annualized equity market returns between 2007-2017 at 5.1% trail average yields of Nigerian Treasury bills and FGN bonds by 400bps and 750bps respectively. In real terms, Nigerian equities underperformed inflation over the period by 660bps and look even poorer in USD terms following significant exchange rate depreciation from NGN130.5/$ to NGN360/$. The period also coincides with ultra-hawkish monetary policy over the last decade which pushed returns on fixed income to elevated levels to support the exchange rate. Furthermore, when one incorporates the higher volatility associated with equities, it becomes quite difficult to justify larger allocations to stocks before investment committees.

In our view, we believe that the greatest impact of the market collapse in 2008-9 was on domestic investor psyche with regards an inability to handle downside risk through diversification. Reeling from overconcentrated positions in equities, we believe that local investors simply cut down on equity exposures and have remained addicted to low volatility fixed income instruments.


Figure 3: Trends in aggregate pension fund equity allocations

Source: Bloomberg, PENCOM

Was this optimal? Using simulated data of a diversified portfolio of pension compliant stocks (using the NSE Pension Index as proxy), Nigerian Treasury Bills and FGN bonds, we were able to generate a return profile that could have been superior to a fixed income only portfolio and would have delivered real returns and less volatility.

Table 1: Simulated Performance of a diversified portfolio [3]

5-year 3-year 1-year
Average Monthly Return 1.0% 1.3% 2.5%
Annualized Return 12.5% 17.3% 33.9%
Annualized Standard deviation 10.8% 11.6% 11.2%

Source: Sigma Research

So then, are equities unchallengeable in the Nigerian context? Within the traditional asset classes, this appears to be the case over relatively long investment horizons.

Though real estate is likely to be a strong contender for the throne, an absence of house price data makes this difficult to demonstrate. Anecdotally, one can argue that investment in real estate along certain locations in Lagos and Abuja is likely to have generated a stronger return profile to even equity investments.  This would certainly make for a case for inclusion of real estate in investment portfolios with prospects of an even lower risk profile and stronger return picture. This would sit well with the current theme of increased variable income exposures in the revised guidelines for pension fund investing.

In closing, a quote by Warren Buffet from his 2018 letter to shareholders of Berkshire Hathaway provides a useful summary of our discussion today.

“I want to quickly acknowledge that in any upcoming day, week or even year, stocks will be riskier — far riskier — than short-term U.S. bonds,” he wrote. “As an investor’s investment horizon lengthens, however, a diversified portfolio of U.S. equities becomes progressively less risky than bonds, assuming that the stocks are purchased at a sensible multiple of earnings relative to then-prevailing interest rates.”



[1] Willis Towers Watson (Feb 2018): Global Pension Assets Study 2018

[2] This excludes holdings of fixed income instruments in balanced funds. Using a naïve assumption that half of funds under management are in fixed income assets, that estimate rises to 86 percent.

[3] This is simulated performance of an investment portfolio holding the NSE Pension Index, Nigerian Treasury Bills and FGN Bonds with respective weights of 45%, 35% and 20%


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This material has been prepared by the investment research unit of Sigma Pensions Limited (“Sigma Pensions”) and is provided purely for informational purposes and is not intended to be used as an investment advice or a recommendation. Sigma Pensions is a pension fund administrator licensed and regulated by the National Pension Commission (PenCom) to provide pension fund management services. The views contained herein are those of the authors as of October 2018 and are subject to change without notice. Sigma Pensions, its directors, officers and employees make no express or implied warranties or representations and shall have no liability whatsoever with respect to any data contained herein with respect to the accuracy or completeness of the information set out in this report or any third party’s use of such information. This information is not intended to reflect a current or past recommendation, investment advice of any kind, or a solicitation of an offer to buy or sell any securities or investment services. The opinions and commentary provided do not take into account the investment objectives or financial situation of any particular investor or class of investor. Investors will need to consider their own circumstances before making an investment decision or speak to a financial adviser. Information contained herein is based upon sources we consider to be reliable; we do not, however, guarantee its accuracy.

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