The Domestic Debt Exchange Programme (DDEP) launched by government in December 2022 – to manage its debt profile – has had a significant impact on the perception of government-issued securities as risk-free investments.
The programme initially sought to exchange GH¢137.3billion worth of Government of Ghana (GoG) bonds for new ones but later revised this to GH¢109.84billion, with government seeing the voluntary exchange of GH¢87billion; which was considered successful.
The process was however met with stiff resistance by some groups, particularly organised labour and pensioner bondholders. The exercise has left a sour taste in the mouths of some investors, especially as the new bonds were issued with an average of circa 10 percent versus 19 percent for the old bonds.
The illusion of risk-free government securities
Government-issued securities such as Treasury bonds and bills have long been considered relatively safe investment options due to the perception of low risk. However, the DDEP has challenged this notion.
The DDEP was to serve as a debt management strategy to restructure the country’s domestic debt by exchanging existing high-coupon bonds for new bonds with lower coupon rates and longer tenors. This resulted in a loss of value for existing bondholders, as they exchanged their higher-yielding bonds for lower-yielding ones.
The DDEP highlighted that government-issued securities are not entirely risk-free, as they are subject to risks such as interest rate risk, credit risk and liquidity risk.
Interest rate risk arises from changes in market interest rates, which can affect the value of fixed-income securities. Credit risk refers to the risk of default by the issuer, in this case the Ghanaian government on its debt obligations. Liquidity risk relates to the ease with which fixed-income securities can be bought or sold in the market. The DDEP has shown that even government-issued securities are not immune to these risks, and investors need to be aware of them when navigating the fixed-income market.
Impact on investor confidence
The DDEP has had a significant impact on investor confidence in the fixed-income market of Ghana. The sudden loss of value for existing bondholders has led to concerns about the safety of government-issued securities, and has shaken investor confidence. Investors who previously considered government-issued securities as risk-free investments may now be more cautious, and may require a more thorough assessment of risks before investing in fixed-income securities.
The decline in investor confidence may also have broader implications for the fixed-income market of Ghana. Reduced demand for government-issued securities may lead to higher borrowing costs for government, as it might need to offer higher coupon rates to attract investors. This could increase the cost of debt servicing for government, and impact the country’s overall fiscal management. Additionally, lower investor confidence may also result in reduced liquidity in the fixed-income market, as investors might be hesitant to buy or sell securities – further affecting market dynamics.
Fixed income securities as safer investment options
Despite challenges posed by the DDEP and associated risks with government-issued securities, fixed-income securities remain a relatively safer investment option compared to other alternatives. Let’s contrast fixed-income securities against other investment options like stocks, real estate, precious metals and currency.
Compared to other investment options, fixed-income securities have distinct advantages.
Fixed-income securities such as government bonds, corporate bonds and Treasury bills are investment options that provide regular income payments and have a fixed maturity date. These securities are typically considered less risky compared to other investment options.
Stocks are known for their potential for higher returns, but also come with higher risks. The stock market can be volatile, and stock prices can fluctuate significantly based on various factors such as market conditions, company performance and economic trends.
Real estate investments have long been a popular choice for investors as they can offer potential appreciation in value and rental income, but can also be affected by factors such as property market trends, location and management risks. However, investing in real estate also carries risks that investors must consider.
Property market trends can affect the value of real estate, as can location of the property. For example, a property located in a desirable area may appreciate in value more than a similar property in a less desirable location. Management risks also need to be taken into account, as poor management can impact rental income and overall value of the property. Additionally, unforeseen events such as natural disasters or economic downturns can significantly impact the value of real estate investments.
Precious metals, such as gold and silver, are often seen as a hedge against inflation and economic uncertainties; but their prices can be volatile. They have been used as a store of value for centuries, and investors often turn to them during times of economic crisis. However, precious metals also carry risks. The prices of gold and silver can be volatile and can fluctuate based on a variety of factors; such as economic conditions, supply and demand, and geopolitical risks. Investors must also consider the costs associated with purchasing, storing and selling precious metals.
Currency investments can be impacted by exchange rate fluctuations, geopolitical risks and economic conditions. Exchange rates can be influenced by factors such as interest rates, inflation rates and political events. Geopolitical risks such as political instability, trade tensions, and terrorism can also impact currency values. Economic conditions such as Gross Domestic Product (GDP) growth and unemployment rates can also affect currencies. Investors in currency markets need to have a good understanding of global economic trends, political events and market sentiment. Currency investments can offer potentially high returns, but they are also highly risky and require careful consideration and monitoring.
In contrast, fixed-income securities provide a predictable stream of income in the form of interest payments and have lower volatility compared to other investment options. They are backed by the issuer’s creditworthiness, such as the government or a corporation, and are subject to fewer price fluctuations compared to stocks or precious metals.
Fixed-income securities also offer different levels of risk depending on the issuer’s credit rating, maturity profile and interest rate, allowing investors to choose options that align with their risk tolerance and investment objectives. Additionally, fixed-income securities can provide diversification benefits to an investment portfolio, as they have historically shown low correlation with other asset classes such as stocks and real estate; thus providing a potential hedge against market risks.
Due diligence
However, despite the relative stability and predictability of fixed-income securities, investors must conduct due diligence before investing. This includes researching and understanding the issuer’s creditworthiness. In the case of government, it should include an evaluation of government revenue versus expenditure; as well as the nature of the expenditure outlays. It would also not be out of place to weigh the track-record of the economy’s managers.
Also, investors should evaluate the interest rate risk, liquidity risk and market conditions, and consider the macroeconomic factors that could affect performance of the Treasury-issued fixed-income investment. Investors should also review the terms and conditions of a fixed-income security, including the maturity period, interest rate and any embedded options, to ensure they align with their investment goals and risk tolerance.
Way forward for fixed income market
The fixed-income market, as in many other markets, is dominated by Government-issued instruments; hence performance and activity on the market will be heavily influenced by sovereign instruments. We expect activity to pick up on the market, and the following activities and events will be key in driving this:
- Timely completion of the debt treatment of Ghana government domestic US dollar bonds and Cocoa bills. Though this is not expected to result in losses compared to those of the local currency bonds, it will still result in some additional losses for investors. This will improve the debt situation of government and further boost government finances.
- The successful completion of negotiations with the country’s largest external creditor group, the Eurobond investors. This will pave the way completing the external debt treatment and provide the necessary relief anticipated.
- A swift completion of negotiations with pension funds, individual and pensioners to reduce the level of old bonds in circulation and improve liquidity of the new bonds, as well as the payment of coupons on the new bonds. This will prove crucial in restoring the fundamentals, and consequently investor confidence.
While a drop in investor confidence may be cause for concern, investors need to remain cautious and vigilant – and not overlook the potential opportunities that may arise during such times.
With careful analysis, consideration of risk tolerance and a focus on diversification, investors can make informed decisions that may help them weather market volatility and achieve their long-term financial goals. The key is to stay the course, maintain a disciplined approach and seek guidance from trusted professionals when needed.
