New inflation calculation tool likely to boost investment yields

The roll-out of a new measure for the calculation of inflation could trigger increased activity in collective investment vehicles (CIVs) such as unit trusts, government securities, pension funds and insurance investment products, analysts say.

While opinion is still sharply divided on the actual impact of the new tool that has led to a sharp fall in inflation levels, fund managers said the CIVs — whose returns trailed the older inflation over the past two to three years — could become more attractive to investors.

While inflation was at more than 20 per cent, fund managers were giving returns of less than 12 per cent, pointing to a negative return of more than 8 per cent.

But with the new inflation measure, most analysts are predicting intensified activity in such investment vehicles driven by positive returns.

“Investment managers will have less pressure to beat inflation numbers, ” said Mr Alex Muiruri, a researcher at Faida Investment Bank.

“With the new method, they can easily achieve returns above inflation as long as the rate does not rise further, ” he said. Investors will be ready to accept lower returns when they consider the prevailing inflation as per the new measure, he added.

Previously, when an investment was producing a 6-10 per cent return, the high inflation numbers appeared to erode the bigger part of the investors’ income.

In 2008 for example, when average annual inflation hovered around 26 per cent, fund managers could hardly measure up the returns, said Mr Muiruri, adding that in most cases they delivered almost less than half that figure.

“Unit trusts are sensitive to perceptions of real cost of living and the change in the tool is likely to trigger more interest in such products”, says an analysis by Zimele Asset Management Services.

“The investment agreements with unit trust funds that have already been signed are likely to remain more lucrative than those that will be based on lower inflation and low-interest rate environment,” the analysis added.

In November the Government announced a change in the method of computing inflation, ditching the arithmetic tool in preference for the geometric method in compiling the data.

And early this month, the Kenya National Bureau of Statistics launched a new consumer price index significantly reducing the importance of household spending on food and setting the stage for reduced volatility in the measure for price movement in the economy.

Policy makers reckon the new figures should enhance the country’s investment credentials arguing that the previous sky high inflation — which were the highest in the region — had become a deterrent to selling Kenya as a favourable investment destination.

“A fall in the inflation rate will mean higher returns on bonds making the bond market a more attractive vehicle” said Mr Eric Kibe, managing director of Sanlam Investment Management (SIM), a fund management firm.

Investors who had put their money in the bourse’s blue chip firms — most of whom also ditched CIVs — saw their returns diminishing as the stock market experienced a bear run at the same time as inflation rose.

In 2009, the stock market lost nearly 10 per cent, while in 2008 it lost 43 per cent.

According to analysts, bond returns were mostly negative with the highest yield being from the 20-year bond that fetched 14 per cent which is still way below the inflation rate.

Mr Kibe says more investors are showing interest in the bond market with the launch of the new inflation monitoring system in what has triggered increased activity in the segment.

The turnover at the secondary bond market hit Sh42 billion in February, up from Sh27 billion in January this year, an all-time high.

“Investors have realised that returns from bonds were in reality higher than previously thought. That caused a major change in the way people saw bonds,” said Mr Kibe.

But he reckons the high bond prices have pushed down yields and banks have not reduced their lending rates because there are other factors apart from bonds that come into play while making the lending decision.

One major consequence of the low inflation rate has been the increasingly lower interest rate being paid for T-bills.

Currently the T-bill rate has fallen to about six per cent from highs of nearly 10 per cent less than two years ago.

Banks, pension funds and insurance firms have traditionally been the biggest takers of the T-bills yet banks have not dropped their lending rates.

However they may eventually be affected by the low rates on T-bills as it becomes more profitable to lend to the private sector rather than the government.

Mr Kibe said that there has been a rush to lock in the higher positive real rates since the recent bonds have been issued at lower rates while the Treasury bill rates have been going down.

Returns increase

“The bond yields have less volatility than equities. But they are sensitive to interest rates, inflation expectations, government borrowing, among other things. When the CBR came down, people saw the prospect of interest rates going down,” said Mr Kibe.

He said that clients have seen their returns increase significantly by last month.

But even with the new calculation, low-income earners who take home Sh24,000 or less a month are still experiencing a higher rate than the rest of the population since most of their money goes into food purchases – the single largest portion of the inflation basket which stands at 36 per cent.

However, labour economists argue that even though the new inflation figures still show that value of current wages has been eroded, it was not enough reason to warrant a review.

“The ability of a company to pay has to be considered. Productivity is also important,” said Mr Jacob Omolo, a researcher at Institute of Policy Analysis and Research (IPAR).

Mr Andre DeSimone of Kestrel Capital, said that foreign investors understood the change in calculation as it now compares with that used in developed European countries. It is now easier to compare country by country investment risks.

“Foreign investors understand the change in the inflation calculation since it now compares with calculations used in developed EU states. However, they will now watch to assess if it might result in more volatile monthly figures,” he said.

He added that the new inflation numbers made returns from bond investment more attractive than was the case before.

Food stores

Analysts at Kestrel Capital are convinced that inflation will only go down as the country’s food stores begin to fill.

“Inflation is expected to ease in the next few months with the onset of the short rains expected in March, ” said Kestrel in its latest report.

For example, according to Nairobi Stock Exchange (NSE) records of March 5, the only bond yielding less than the inflation rate of 5.2 per cent is the seven-year bond which matured on Monday and had an implied yield to maturity of 4.0 per cent last week, indicating that the holder of the bond was earning 0.4 per cent per day for the remaining days amounting to an annualised yield of 146 per cent.

Citibank analyst David Cowan says the new method should in the medium to long term reduce the volatility of the inflation rate.

“In our view, these changes do not really reflect political manipulation of the statistics, but are normal technical changes to their calculation,” said Mr Cowan.