The highest inflation in 5 years is pushing Nigerian consumers way beyond their financial limit. Many Nigerian manufacturers are left with no option, but to take high interest loans just to be able to stay afloat, while new startups turn to venture capitalists outside Nigeria for US dollar loans.
Inflation is the increase in the price of goods and services over a specific period of time in an economy. The manifestations of inflation in an economy include; reduction in consumer purchasing power, high prices of goods, increased poverty etc.
For active participants of the capital and stock market, inflation can lead to market volatility, it can affect the profits of companies listed on the stock market, higher interest rate can reduce the value of cash savings etc.
In June 2022, the National Bureau of Statistics in Nigeria reported that the nation’s inflation rate has risen to 19.64%. The World Bank predicts Nigeria’s inflation will likely shoot to past 20% later this year.
As part of efforts by the CBN to reduce inflation, the interest rate or MPR rate was hiked to 14%. As the storm of inflation rages on, you must think of ways to shelter your investments. The following points will give strategies to ensure this inflation does not take a toll on your investments and finances.
Taking Shelter from the Headwinds
- Build a Diversified Portfolio
Diversification is an investment strategy used to minimize risk. It is premised on the idea that rather than concentrating all your assets in one place, spreading them across different asset classes will reduce your risk exposure.
The justification for diversification is that while other asset classes might be doing badly, others with positive performances will cover up for it, as different asset classes perform differently, in different economic situations. By diversifying your portfolio, you hedge your investment against the risks of the economy at any time.
Index funds are a member of the collective investment scheme (CIS) family, and are the custodians of the Nigerian capital market. Index funds are a good diversification vehicle. This is because they track a particular index, letting you own bits of all the shares in that index. The Nigerian Exchange (NGX) has several indexes to invest in. Examples include:
- NGX Pension index: tracks the top 40 most liquid & most capitalized companies on the NGX
- NGX30 index: that tracks the 30 best performing companies listed on the NGX
However, you cannot invest directly in an index like NGX30, you need to pass through a fund manager. These fund managers pool money from investors, and buy the stocks that make up the index. Index fund managers aim to replicate the performance of the index and not beat it. See below some fund managers and the index they track:
- Stanbic ETF30: tracks and aims to replicate the NGX 30 index performance. It gives you exposure to all the 30 companies that constitute the NGX 30 index.
- Greenwich ALPHA ETF: Also tracks and aims to replicate the NGX 30 index. Gives you exposure to the 30 companies constituting the NGX 30 index
- Use Exchange Traded Derivatives (ETDs) for Risk Management
As the name implies, exchange-traded derivatives are financial contracts traded on the NGX. For now. Nigeria’s ETD market is the first in West Africa and prior to its launch, investors had limited ways of managing risk.
The Managing Director & CEO of the NGX exchange Mr. Temi Popoola said: ‘we believe that derivatives will potentially address significant risk management needs of market participants, such as our pension funds, our asset managers, our corporate treasuries, and trading license holders; being the first line of contact for investors and market players, with the necessary tools for asset allocation and cost management for effective portfolio management.
Futures contracts are the only ETD available on the NGX. They are a type of derivative contract where you enter into an agreement to buy or sell a specific quantity of the underlying asset, at a specific date in the future, and at a specific price.
The holder of the futures contract is obliged by law to buy or sell the underlying asset, at the maturity of the contract, or settle the price difference in cash. The NGX currently has two futures contracts listed namely:
- The NGX 30 index futures
- The NGX pension index futures.
For NGX 30 index futures, if you already own shares of an index fund that tracks the NGX30, as we explained earlier in the topic, then you can manage risk.
Example, if you harbor fears that the NGX30 index might decline in performance in one month, you can buy a futures contract that gives you the right to sell off your NGX 30 index fund shares, at today’s price, one month from now. The same thing applies for NGX pension index. By doing so you lock in today’s price for tomorrow thus managing risk.
- Save Cash in Foreign Currency
Another way to hedge against inflation in Nigeria is to save your cash in a stronger foreign currency through a domiciliary account. When inflation is high, there is a fall in the value of the Naira against major foreign currencies.
By saving in foreign currencies, you make a profit off the fall in the Naira which can become useful in combating the effects of inflation on your personal finances.
Saving in foreign currency is also important for online shoppers & traders, retail online forex traders who use derivative contracts to try to profit from exchange rate volatility, and for students schooling overseas to house funds. A foreign currency account can make it easier to buy goods, and trade online, thereby bypassing the exchange rate discrepancies.
- Don’t put your money in Instruments that you don’t Understand
In order to hedge against the risks many people tend to invest in instruments that they don’t fully understand. Many unregulated brokerages target Nigerians via online ads that promote trading for ‘financial freedom’ & way to hedge against risks. But this is not totally true.
Many young Nigerians enter into online forex trading & gambling to earn money & protect themselves from rising inflation, which is very risky & must be avoided. For example, in the list of top websites in Nigeria, many foreign online forex trading websites are quite popular in Nigeria. But many of these are unregulated.
The forex brokers in Nigeria that are regulated with tier-1 regulators don’t promote forex & CFD trading as a way to make a living, as there are strict regulations on the marketing. But offshore brokers don’t have to follow these rules. Most of the forex brokers are fake & operating without a license or with licenses from offshore island-based regulators. But many young people fall for these scam brokers that advertise forex trading & investing in foreign markets as means to hedge.
Also, it is important to know that forex trading is not regulated by the SEC yet & you are trading with these brokers at your own risk.
- Lower Your Exposure to Long-Term Bonds
When government or organizations want to raise money, rather than go to banks or other financial institutions, they just go to the public, and issue bonds to be paid back with a specific interest rate.
During times of high inflation, you should lower your stake in long term bonds between five to ten years, as the interest/profit can get drowned in high inflation. That being said you should pay close attention to Eurobonds.
Euro bonds are debt instruments issued in a currency different from the home nation’s currency. In Nigeria, if a bond is issued in a currency other than the naira, it is said to be a euro bond. Euro bonds present you with the opportunity to earn interest in a stronger foreign currency.
The latest euro bond offering from the federal government is the $1.25billion Eurobond, with a seven-year tenor, and at 8.375% interest per annum.
In Nigeria, participating in the Eurobond is as easy as participating in other bond offerings. It can be bought in the primary market at the initial offer terms, or in the secondary market via your stockbroker.
- Increase Your Exposure to Defensive Stock
Defensive stocks are stocks that tend to perform relatively the same irrespective of the overall economic conditions in a country. What this means is that they tend to defy economic realities.
During times of high inflation, investors usually throng these defensive stocks due to their capacity to resist inflation. They outperform the general stock market because they usually belong to industries where there is a constant demand for their products such as: beverages, utilities, healthcare etc.
These products always witness a constant amount of demand all through the year. It is for this reason; defensive stocks are seen as a ‘safe haven’. As an investor in Nigeria going through the inflation, defensive stocks can help you weather the storm as they tend to be resilient to the economic downturn.
- Increase Exposure to Real Estate
REIT’s or Real Estate Investment Trust is a company that uses pooled resources from the public to buy or finance the building of income generating real estate ranging from office buildings, residential and non-residential buildings.
REITs offer investors many perks which include; the steady payment of dividends. A large percentage of its income is usually paid out as dividends. Also, it guarantees long-term capital preservation. REITs can increase their house rent to reflect the current inflation rate.
You can invest in REIT funds listed on the Nigerian Exchange Limited (NGX). Examples of REITs on the NGX include; UPDC REITs, Union Homes, Ronchess plc. etc.
This is not the time for an investor to act recklessly in the market. Rather, the period calls for financial caution. Your actions and inactions as an investor should be carefully thought out.
You should think of rebalancing your portfolio taking inflation into account and most importantly, don’t quit the market.