Bond investors recorded net capital losses of Sh5.1 billion when selling their securities in the secondary market on the Nairobi Securities Exchange (NSE) in the second quarter of the year, as prices fell due to rising interest rates on new debt auctions.
Data published by the Capital Markets Authority (CMA) shows that a majority of listed bonds were being traded at prices below the par value by their holders, resulting in the loss of part of their principal.
During the quarter, bonds with a face or par value of Sh152.53 billion were traded at the exchange, but the consideration realised (traded turnover) stood at Sh147.39 billion due to the price discounts.
Medium-tenor bonds with between eight and 12 years to maturity suffered the biggest value erosion in the period, while infrastructure bonds and recent issuances — which already carry high interest and are thus unlikely to be sold—had the best value for sellers.
Bond yields and prices usually feature an inverse relationship where a rise in one rate signals a decline in the other.
The implied yields are, however, different from the coupon rates on the actual bonds, which is the fixed interest that the government pays to holders.
In the secondary markets, bonds are usually sold at a premium or discount of their face value — the actual value or cost of the bond at its first issue.
When rates on new issuances in the primary market go up, investors seek to sell existing holdings (which pay less interest) in order to reinvest in the new issuances to lock in higher returns.
This rise in supply in comparison to demand pushes down the prices that they are willing to accept for their papers, hence the inverse relationship between yields and prices.
On the other hand, when new issuances are paying lower interest compared to the bonds already in issue, existing bond owners are likely to hold onto their securities, and those wishing to take them off their hands are forced to pay a premium to entice them to sell.
Investors holding bonds to maturity are, however, sheltered from the shifts in yields and prices as they stand to earn the face value of the paper at maturity.
In the second quarter of the year, the bonds turnover at the NSE stood at Sh147.41 billion, representing a 9.3 percent decline from the Sh162. 5 billion that was traded in the first quarter of the year.
This fall in traded volumes is indicative of a reluctance by some holders to trade their bonds due to potential capital losses due to selling price discounts.
Interest rates on government bonds have generally risen this year, with returns of as much as 16.8 percent, which was recorded on a five-year paper sold last month.
The Treasury has responded to the high rate demands by issuing shorter bonds, including a two-year paper currently on sale, to avoid locking itself into high debt service costs for a long period.
