With interest rates at an all-time lows and traditional fixed income securities like Treasury Bills becoming unable to meet investors’ income needs, diversifying across asset classes can never be more important now than ever before. Treasury bills and other “safe” sources of income are yielding a fraction of what they once did, although the recent auctions by the CBN were done at rates indicative of a rate hike in the near future, the mood and fundamentals of the economy does not point decisively to that effect. The fundamentals may be suggesting that interest rates will remain low for relatively longer.
Three years ago, (precisely on Nov 20th 2013), the income from a N100,000 183-day Tbill was roughly N5,667 but as at January 22, 2016, a similar instrument offers just N3,192 in return. Indeed, today, yields are farther below the rate of inflation than they were three years ago. Though coupon rates on existing bonds or core fixed income remain the same, their market yield are near all-time lows. This leaves investors with huge interest rate and reinvestment risk for those bonds that will mature soon.
The combination of interest rate risk and already low yields requires that investors should diversify their fixed income investments by looking beyond core bonds for income. Broadening the search for yield would entail diversifying across asset classes. Dividends are and can be another important source of income, therefore investors should look to broadening their investment income base by looking favorably towards equities especially when they think the market has found its bottom. In addition to being an additional source of income, dividends can help reduce overall portfolio volatility. Investors may also look to increase their investments in pension funds, especially those who are nearing retirement. This is good, not only because of the tax benefits but because of the sterling performance of many pension funds in Nigeria, most of which recorded double digit performance for 2015. Investors can generate income from bond mutual funds, as well as other types of investments, such as REITs and commodity ETFs. While this allows them to further diversify their portfolios while generating income, it may be necessary to do so in accordance with their risk appetite and tolerance as well as with the advice of credible financial advisers. One tool that can be of help in the diversification exercise is correlation analysis of various asset classes as to uncover how they relate to each other.
No matter how sound the above may appear, it should not be construed as an investment advice and should not be relied upon for investment decisions. Investors should consult their financial advisers should they be interested in any of the points raised here.