Money Market funds today can offer investors yields of 10.0% pa, or more, net of fees. These yields are the best offered by Money Market funds in almost three years and are far higher than T-bill yields. How has this come about?
Where to Get the Best Interest Rates
Over the past four months, the policy rate of the Central Bank of Nigeria (CBN) has risen from 11.5% to 14.0%. No doubt, individual savers thought that interest rates were going to rise substantially. They have, but probably not in the way they expected. After all, the interest rate on 90-day Treasury Bills has only risen from 2.81% to 3.93%, well short of the CBN’s policy rate. So, where can individual savers get the best rates?
The answer is Money Market funds. To explain why, we need to look at the deposit rates available from commercial banks and the rates available on other instruments that Money Market funds invest in.
Money Market funds can invest in bank deposits. And these are attractive at the moment because commercial banks are offering rates in the region of 13.0% – 15.0% per annum for 90-day deposits. This probably comes as news to the majority of individual deposit account holders, whose personal accounts may yield much less than this: but these high rates are usually only available to large deposits of N1.0bn (US$2.3m) and upwards. It makes sense, therefore, for individual savers to pool their money in Money Market funds to take advantage of this
At the same time, most Money Market funds cannot just invest in bank deposits. They are obliged to invest at least 25.0% of their holdings in government securities such as T-bills or securities issued by the CBN. So, a Money Market fund today might invest in some juicy bank deposits (supposing it has N1.0billion or more of cash) but might have to dilute that yield by investing in relatively low-yield T-bills as well.
This is where it gets interesting because Money Market funds may instead invest in the Special Bills of the CBN. The yields of Special Bills have climbed recently and last week reached 12.3% pa. So, a Mutual Fund can combine bank deposit rates with Special Bills, along with other instruments, to achieve much higher yields than before. Today, a typical Money Market fund yield may be as high as 10.0% pa, net of fees, or slightly more.
Why are banks offering such high deposit rates on their deposits? The answer to this question is part of the jigsaw of the interest rate picture in Nigeria today. The banks are offering high rates for term deposits, in our view, as an indirect consequence of the cash reserve requirement (CRR). The CRR is the percentage of customer deposits that banks are required to lodge with the CBN. This percentage is officially 27.5% but is generally acknowledged to be, in practice, 50.0% or more.
A low CRR has little influence on deposit rates because people, for the most part, tend not to draw on all their deposits. So banks are not affected by keeping a proportion of deposits with the central bank: but at a certain level of CRR, the demand for deposits affects liquidity, and banks have to offer high rates to keep their deposit levels high.
This last point is important, namely that money market conditions are transitory, constantly changing. Banks may offer high deposit rates for large term deposits today, and Special Bills may enjoy high yields today, but nothing stays the same for long. It is just that Money Market fund yields look better now than they have for almost three years..
Last week, the exchange rate at the Investors and Exporters Window (I&E Window) weakened by 0.30% to N430.33/US$1. Elsewhere, the foreign exchange (FX) reserves of the Central Bank of Nigeria (CBN) gained 0.09% to US$38.95bn, the highest level since 8 August, improving the ability of the CBN to continue intervention efforts across the various FX windows.
The CBN has maintained the exchange rate in the I&E Window within a narrow range all year and with its FX reserves close to historic highs we expect it to be maintained at very close to current levels for several months, at least.
Bonds & T-bills
Last week, trading in the Federal Government of Nigeria (FGN) bond secondary market was mixed, albeit with a bullish tilt, as the average benchmark yield for bonds fell by a marginal 1bp to close at 12.81%. Across the curve, the yields on the 7-year (12.68%) and 10-year (13.00%) bonds were unchanged, while the yield on the 3-year bond (+99bps to 13.10%) expanded. Nonetheless, our view remains that the combination of thin system liquidity and elevated Federal Government domestic borrowing will continue to drive yields upwards over the coming months.
Activity in the Treasury Bill (T-Bill) secondary market was bullish as the average yield for Tbills shed 5bps to 7.80% following improvements in system liquidity. Notably, the yield on the 286-day T-bill compressed by 1bp to close at 6.79%. At the T-bill primary auction, the DMO offered and allotted N295.53bn (US$703.09m) worth of bills. The auction recorded a total subscription of N311.12bn, implying a bid-to-cover ratio of 1.05x (vs 1.25x at the previous auction). Consequently, stop rates across the 91-day (+50bps to 4.00%), 182-day (+50bps to 5.00%), and 364-day (+105bps to 8.50%, implying a 9.29% yield) bills rose. Elsewhere, the average yield for secondary market OMO bills contracted by 2bps to 11.14%, with the yield on the 249-day OMO bill falling by 3bps to 11.22%.
Last week, the price of Brent rebounded and offset the prior week’s loss as it gained 4.41% w/w to settle at US$100.99/bbl. Brent is up 29.84% year-to-date and has traded at an average of US$104.10/bbl, 46.85% higherthan the average of US$70.89/bbl in 2021.
Despite concerns sparked by hawkish comments by the US Federal Reserve Chairman at the Jackson Hole Conference, oil prices managed to end the week positive. Most of the gains were due to optimism around talks among Saudi Arabia and other members of the Organization of the Petroleum Exporting Countries and allies (OPEC+) on cutting oil output to balance the market. In addition, the prospects of an agreement being reached on an Iran nuclear deal remained elusive, suggesting that supply is unlikely to increase soon.
Nevertheless, in this exceptional year for oil prices, we maintain that prices are likely to remain above the US$73.00/bbl set in Nigeria’s government budget.
Last week, the NGX All-Share Index halted two consecutive weeks of losses, as it gained 0.63% w/w to settle at 49,682.15 points, the highest level since 17 August. Consequently, its year-to-date return rose to 16.31%. Honeywell Flour Mills (+12.40%), Stanbic IBTC Holdings (+8.93%) and Airtel Africa (+7.06%) closed positive, while Seplat Energy (-8.44%), Flour Mills of Nigeria (-7.06%) and BUA Foods (-6.92%) closed negative. Performances across the NGX sub-indices were broadly negative, with the NGX Industrial Goods (-4.19%), NGX Oil & Gas (- 4.08%), NGX Consumer Goods (-1.73%), NGX Pension (-0.90%) and NGX Banking (-0.69%) indices declining. Conversely, the NGX Insurance (+3.88%) and NGX-30 (+0.48%) indices closed positive
Model Equity Portfolio
Last week the Model Equity Portfolio gained 0.48% compared with rise in the NGX All-Share Index of 0.63%, underperforming it by 15bps. It has gained 20.05% year-to-date compared with a gain in the NGX-ASI of 16.31%, outperforming it by 374bps.
The biggest gain last week came from our nearly-neutral position in Airtel Africa which delivered 187bps, followed by our overweight position in MTN Nigeria which delivered 35bps while our underweight position in Nestle Nigeria delivered 13bps. Our overweight position in Dangote Cement cost us 103bps while our strongly overweight position in Seplat cost us 41bps and our nearly-neutral position in BUA Foods cost us 33bps. It was noticeable that our overall position in banks made a small positive return, of 4bps in total.
We need to take action. Our overweight notional position in Dangote Cement is costing us too much and the market is reacting to its disappointing Q2 results, results that we thought would surprise on the upside. We will make notional sales in this stock this week to bring our position in line with a neutral index weight.
Our overweight notional position in Seplat is also beginning to cost us. It delivered good Q2 results, but the market is treating falls in oil prices as a reason to take profits in the stock, perhaps not surprisingly. Here too we will make notional sales this week to bring our position in line with a neutral index weight. We made notional sales in Okomu Oil and Presco in mid-July in response to weakness in international palm oil prices, but we should have sold more as these residual positions continue to cost. We will continue to make notional sales in these two stocks this week, liquidity permitting. Our overweight notional position in MTN Nigeria earned us 35bps last week but the overweight element in this position, since we added to our nearly-neutral position in mid-July, has cost us 54bps up until now, which is fartoo much. The company is performing well, Q2 results were good and in-line with expectations, and the stock appears to be cheap relative to peers. It has many of the elements for outperformance but perhaps market sentiment at this point, on balance, does not favour it. We will begin to make notional sales in this stock this week towards an index-neutral position.
These actions, if we can get them done (we respect actually market liquidity when making notional trades), will increase the cash component in the Model Equity Portfolio, with the result that we will be exposed if there is a broad-based market rally. However, the fact that Naira bond yields are improving, and the fact that there are interesting offerings from Money Market funds, suggest that a chances of a broad-based market rally are not high.