NEWS | Africa market bond exposure: Understanding the risks and opportunities
Africa market bond exposure: Understanding the risks and opportunities
Is it worth taking on a bit more risk to achieve potential return? Londa Nxumalo explains the relationship between risk and return in the fixed income context and discusses factors to consider when looking at the opportunities and threats across Africa. The situation in the developed market fixed income world looks very different to emerging markets, which Mark Dunley-Owen, from our offshore partner Orbis, unpacks in his article.
The relationship between risk and return is well documented. In short, investors should demand a higher return from investments that carry a higher risk. In fixed income, the potential for returns – in the form of coupons and capital gains – is captured by the bond yield (which is the coupon amount/price). A high yield signifies a high potential return. A high potential return generally comes with high risk, and therefore a higher yield would point to higher risk. Low return in itself can be a risk – but many investors seem to be ignoring this factor, opting for safety even if it means no yield. Because bond prices move inversely to yields, investors who buy bonds at abnormally low yields would be exposed to capital losses in the event that those yields normalise.
Graph 1 shows the hard currency yields of three developed countries and six major African bond issuers. There is a clear negative relationship between the credit quality of a country (the willingness and ability to repay interest and capital in full and on time) and the yield on its bonds. In other words, the lower the credit quality, the higher the yield.
Developed countries have better credit ratings (or lower credit risk) and therefore offer lower yields. These are often considered safe havens. On the other hand, the African countries offer increasing yields as the credit quality deteriorates.
October 11 2021 By Londa Nxumalo - Allan Gray