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Kevin Mwanza: Tapping into Market Bubbles
Date Published: Friday December 04, 2009
Times are hard. At least for most people. All these have been caused by the global financial crisis that emanated from several financial market bubbles bursting across the global financial markets. A market bubble is simply a situation where securities are grossly over valued due to unsustainable demand. And when this demand reaches a breaking point, it bursts and leaves investors holding valueless stocks or real estate assets.
In Kenya, we've only recently witnessed a stocks market bubble burst. While the stocks market bubble burst in mid 2008 another bubble may be forming in the bonds markets. Both state and corporate bonds have received renewed interest from investors, especially institutional investors. The type of interest that creates market bubbles. We are yet to witness a real estate bubble burst, although the real estate market in Kenya is showing signs of a bubble.
Bonds, being fixed income investments, are quite different from stocks and real estate. When buying bonds, an investor can essentially determine exactly what the expected returns will be if he holds them to maturity. For instance, buying into the recent fifteen years KenGen infrastructure bond that pays 12.5 percent interest will mean the investor gets 12.5 percent interest on the initial investment sum each year for fifteen years. And at the end of fifteen years (maturity) he gets the initial investment amount back. That's very different from stocks or real estate, which doesn't give a known rate of return, has no assurance that the initial amount invested will be recovered in the future.
Similarly, bubble in bonds market is a bit different and more about the potential for lost income opportunity when interest rates rise. Bonds usually have inverse relationship with interest rate. If you buy and hold your bonds until their maturity (assuming the issuer doesn’t default) your investment will not be affected by a bonds bubble.
Looking at the recent bond results gives a clear picture that there's over enthusiasm in these markets that may affect the interest rates. Further more investing in bonds is particularly different and complex compared to stocks, which explains why less individual investors venture into them. They'll rather access them through unit trust offered by mutual fund firms such as Old Mutual, Zimele or BAAM.
But does this mean that there's money in bonds now than before? Not really. This shift in investment appetite only indicates that other investment avenues such as equities and the money market have had reduced earnings and become much riskier due to uncertainties, making fixed securities more attractive.
Bonds or any other fixed interest investments give a sense of security in times of uncertainty. No matter how small the interest they give, it's usually better compared to losses an investor may easily incur in the equities or real estates. However, even during the low seasons in the equities or any other markets, opportunities to make some gains still abound albeit far much less than during a market booms.
Unfortunately, most investors in our markets tend to take a short term view (speculative) that can only work in a bubble, where securities prices are constantly going up and a chance to make gains is more likely. But this kind of speculative investing cannot work in a subdued market like what we have right now.
If investors take the long view, it's possible to detect a pattern that emerges in bubbles and their aftermaths. These patterns creates great opportunities that can be tapped into. Long term investors can easily tap into the legions of speculative investors that stream into the market during the bubble. Such dynamic is what most institutional investors' cash on.
Another invaluable benefit the recent financial markets turmoil has given us is education. We now know that even the most diversified portfolio can lose almost half of its value in a matter of few months. Diversification does not necessarily mean that we are safe. Notwithstanding the damage to individual companies and stockholders, bubbles play a determinedly healthy role in the continuing success of the financial industry.
By Kevin Mwanza
Tujuane Staff Writer
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