Why alternative asset classes could make capital markets great again

Guest traders and stock brokers at the Nairobi Securities Exchange:  Reduced  trading activity forced the bourse to issue a  profit warning for 2016. SALATON  NJAU
Guest traders and stock brokers at the Nairobi Securities Exchange: Reduced trading activity forced the bourse to issue a profit warning for 2016. SALATON NJAU 

This year hasn’t been good for stocks. As at December 28, the NSE All-Share index was down 10 per cent while the NSE-20 Share index had lost 22 per cent.

For the bourse operator, the Nairobi Securities Exchange (NSE), the second full year of operations as a demutualised listed entity has provided some reality check.

As at the time of my writing, equity turnover was down 30 per cent year-on-year while the total number of shares traded had retreated by 15 per cent.

Because the bourse makes money by slicing off a portion of turnover as commissions, the reduced trading activity forced it to issue a profit warning for FY2016.

Secondary bond trading, however, had a stellar performance with turnover up 42 per cent; however, the razor-thin margins could not help the exchange recoup some of the lost volumes on the equity side. 

I say it’s now time to move a step further above the spot-based products. I don’t think the old straight-line buy-low-sell-high narrative that has been pitched to local equity investors for years, especially the less sophisticated ones, can continue being the bedrock of the stock market in 2017 and beyond.

The local investment scene has incubated enough sophistication so the bourse needs to introduce a new level of sophistication in its offering via alternative asset classes; and I’m looking forward to a number of such product platforms being launched in 2017.

The first one is stock market futures. I think the groundwork, including necessary legislations, has now been laid.

In the course of 2017, I expect the NSE to introduce both single-stock and index futures.

For single-stock futures, only three stocks (Safaricom, KCB and Equity), in my assessment, will qualify initially. Broadly, these futures products will be derivatives of the underlying spot market — as in, they will be referencing actual daily spot trades on stocks. Off the back of stock market futures, I would have hoped that warehouse receipting could easily feed into such a loop.

This is because, generally, futures represent tradable contracts in which the buyer and seller agree to trade at a specific future date. Futures have been historically associated with soft commodities such as wheat, rice or maize.
However, warehouse receipting has been in the pipeline for quite some time now and, in my assessment, may not fructify in 2017.

The second thing I’m looking forward to in 2017 is the secondary trading of Treasury bills.

Between January 2016 and at the time of my writing, about Sh38 billion worth of Treasury bills had been rediscounted at the Central Bank of Kenya.

This is huge, and although it only represented just about nine per cent of total secondary market bond turnover so far, it has the potential to grow significantly.

Enhance platforms

I’m also hoping that the plan to merge the two securities depositories — Central Depository and Settlement Corporation (CDSC) and CBK — could be actualised in 2017.

If it comes to fruition, it will greatly enhance such platforms as the proposed securities lending framework (and even hasten the introduction of short-selling) as well as fast-tracking settlements to include even same-day trades.

As of today, CDSC is the custodian of stocks and corporate bonds listed at the NSE while CBK holds all government securities.

Lastly, I’m looking forward to NSE admitting its first exchange-traded fund (ETF). Initially, it could have a structure as simple as tracking the NSE 25-Share index, before it starts being coated with additional derivatives.

Essentially, if these alternative asset classes hit the market then we should look forward to a very vibrant capital markets in 2017.

Mr Bodo is an investment analyst