Investment Education Series The Art of Investing Introduction Investing is an art and science that requires creativity, experience and good judgement on the art side and quantitative skills, precision on the science divide to achieve mastery of the process. Investment means putting your money to work for you and it essentially involves saving for the future as well as meeting today s income needs through strategic asset allocation, tactical changes in asset allocation to capture temporary imbalances in markets, and successful selection of particular investments in each category. There are two main ways in which a person gains from an investment. The first is by capital gains, the difference between the purchase price and the sale price of an investment. The second is investment income, the money paid to the holder of the investment by the issuer of the investment. Depending on the type of investment, the source or mix of the total gain will differ. And in some cases, these different sources are taxed at different rates, so it is important to be aware of each. What investment is not Investing is not gambling. Gambling (lack of analysis and lack of safety) is putting money at risk by betting on an uncertain outcome with the hope that you might win money. Part of the confusion between investing and gambling, however, may come from the way some people use investment vehicles by putting money into investment instruments with an expectation of gain without thorough analysis, without security of principal, and without security of return. Speculation on the other hand occurs when investors ignore or fail to thoroughly consider analysis of business decision-making data in making their investment decisions. The mantra of "buy low and sell high", is not that simple! As anyone who has actually tried investing, knows that such simplistic approaches face an uphill, if not impossible, challenge. Investment Vehicles There are many different ways you can go about making an investment. This includes putting money into stocks, bonds, mutual funds, alternative investments (which has a wide range of tangible and intangible products), or starting your own business. Each of these investment vehicles has salient features, which we will discuss with respect to the Nigerian market. Cash Investment Cash investment such as bank bills and bank accounts are best suited for the funds you may need immediately, for your rainy days or emergency funds. In Nigeria, cash investment is considered as appropriate primary investment by many. From the local esusu collection, and informal contribution groups to formal organisations such as banks and microfinance banks, cash investment dominates Nigeria s economic landscape.
As the saying goes, cash is king because of its ease of access and is considered the safest of investment classes. The problem with cash is that interest rates are close to zero and the spending power of your money will wither away with even a relatively low rate of inflation. Features of cash investments: - There is no entry or exit fee. - The money will be on call - Interest is credited daily, monthly or annually. - For long tenor investment, interest is compounded Shares or Equities (Stocks) Investment Shares represent a fraction of ownership in a business. A business may declare different types (classes) of shares, each having distinctive ownership rules, privileges, or share values. Ownership of shares is documented by issuance of a stock certificate. Stocks fall into two main categories made of equity shares and preferred shares. Equities generally offer a greater return on investment than other investment vehicles, but they are also the most volatile asset. Shares are available to investors in the primary market through private placements, public offers and secondary market. These transactions are brokered by stock broking firms who earn commission. Features of Shares Limited Liability Ordinary shareholders have limited liability. In other words, their liability is limited to those shares. They cannot be forced to pay anything out of their own money in the event of bankruptcy. They are fully protected against any financial obligations incurred by the organizations. Liquidation Rights If a company goes bankrupt and liquidates all its assets, the ordinary shareholders have the right to receive their share of sale proceeds. However, they are the last to receive money after the creditors, bondholders and preference shareholders are paid. Pre-emptive Rights If a company plans to issue new shares, existing shareholders have the rights to subscribe to new shares, often at lower prices, before they are issued to the public. Voting Rights Ordinary shareholders have the rights to vote in general meetings of the company. Each share carries the right to one vote. Shareholders can exercise control by electing the board members, who will oversee the major decisions and policies implemented by the management of the company.
Preference shares are comparatively less risky for investors. Preference shareholders rights to vote are usually contained in the Company s Article of Association. Dividend Payments Ordinary shareholders are entitled to a share of the profits in the form of dividend. However, the amount of dividend payments is not based on a fixed percentage rate; it is recommended and decided by the board of directors. Preference Shareholders are entitled to a fixed rate of dividend and they will receive a fixed rate of dividend whether the company has made a huge profit or even a loss. Mutual Funds A Mutual fund is a professionally managed investment vehicle that is made up of a pool of funds collected from many investors for the purpose of investing in securities such as stocks, bonds, money market instruments and similar assets. The securities purchased are referred to as the fund's portfolio. Mutual funds are operated by money managers, who invest the fund's capital in order to produce capital gains and income for the fund's investors. A mutual fund's portfolio is structured and maintained to match the investment objectives stated in its prospectus. Nigerian asset and investment management companies are currently administering several mutual funds. Types of Mutual Funds Growth A growth fund invests primarily in the common stock of well established companies. This type of fund may invest for long-term capital gains and is not intended for an investor who seeks income. Balanced A balanced fund, as the name implies, invests for both growth and income. The fund will invest in both equity and debt securities. A balanced fund seeks to provide long-term growth through its equity component as well as income to be generated by the portfolio's debt securities. Money Market A money market fund seeks safety of principal by investing in high quality, shortterm securities. This type of fund is designed with the aim that an investor's principal should not decrease in value. A money market fund seeks to provide a regular distribution of income which is determined by short-term interest rates. Features of Mutual Funds They give unskilled investors access to professionally managed, diversified portfolios of equities, bonds and other securities. There are different time frames ranging from fixed/ close to open ended.
It gives an investor the choice to decide whether you should invest in a fund directly or through a broker dealer. Each shareholder participates proportionally in the gain or loss of the fund. Mutual fund units, or shares, are issued and can typically be purchased or redeemed as needed at the fund's current net asset value (NAV) per share. Bonds Investment A bond is a debt security in which the authorized issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay interest (the coupon fixed intervals (semiannual, annual, sometimes monthly ) to use and/or to repay the principal at a later date, termed maturity. Bonds provide the borrower with external funds to finance long-term investments for corporate organizations, or, in the case of government bonds, to finance current expenditure. Types of bonds Corporate Bonds Are issued by public quoted companies to raise external funds to finance longterm investments, recent corporate bond issued include UBA & FLOURMILLS bonds issue. Government or Treasury bonds Are issued by the Federal and State Government in Nigeria to finance current expenditure. Sovereign bonds They are issued by national governments in foreign currencies. An example is the Nigerian Government 10-year sovereign bonds which sold 65 billion naira ($409.45 million) when it was auctioned in November 2011 by the Debt Management Office. Features of bonds Maturity date The date on which the issuer has to repay the nominal amount. The Maturity can be any length of time, although debt securities with a term of less than one year are generally designated money market instruments rather than bonds. Coupon Is the interest rate that the issuer pays to the bond holders. Usually this rate is fixed throughout the life of the bond. There is an issue price, called the par (or the face value ). The biggest risk is that the borrower defaults i.e fails to pay back the principal.
Alternative Investment Alternative investments refer to investment products other than the traditional investments in stocks, bonds or mutual funds. Most alternative investment assets are held by institutional investors or accredited, high-net-worth individuals because of their complex nature, limited regulations and relative lack of liquidity. Alternative investments include hedge funds, managed futures, real estate, commodities and derivatives contracts. While the small investor may be shut out of some alternative investment opportunities, real estate and commodities such as precious metals are widely available. Types of Alternative Investment Real Estate Real estate is perhaps one of the oldest alternative investment options with substantial growth potential. Individuals and institutions with substantial funds can invest in commercial and rental properties in Nigeria and the worldwide market. Liquidation of investment in this asset class however takes time. Precious Metals Investing in precious metals like gold and silver can help you reap substantial benefits. In fact, investing in gold and silver is considered to be the best investment during recession as the prices of these metals have been known to always increase with time. In fact, the price of gold is trending high currently. Private Equity Funds Private equity firms, high net worth individuals, large financial institutions and institutional investors come together to create private equity funds by pooling their combined wealth for a fixed amount of time in the form of a fund. Art & Antiques A very specialized alternative investment option is putting your money into art and antiques. World over, rare masterpieces of art including paintings and antiques are sold through auctions for a fortune. Some wealthy individuals buy them as collectors while some businesses buy and sell them as pure investments with potential for growth in value. For high net worth individuals, investing in antiques and art is a viable investment option. Features of Alternative Investment Relative illiquidity, for which investors require a higher return. Improved diversification benefits compared to a portfolio consisting solely of stocks and bonds. High costs for due diligence because of complex investment structures, the need for specific expertise, and a lack of transparency with respect to performance communication. Difficulty in establishing appropriate benchmarks and thus in performance appraisal Money Market Instruments Money market refers to a collection or group of financial institutions or exchange system set up for dealing in short-term credit instruments of high quality.
These short-term instruments involve a small risk due to loss, because they are issued by obligors of higher credit rating and they mature within one year. The money market is a short-term debt market. Types of money market instruments Treasury Bills The Treasury bills are the short-term money markets securities that mature in a year or less than that. The purchase price is less than the face value. Certificate of Deposit The certificates of deposit are basically time deposits that are issued by the commercial banks with maturity periods ranging from 3 months to five years. The return on the certificate of deposit is higher than the Treasury Bills because it assumes a higher level of risk. Commercial Paper Commercial paper refers to unsecured short-term promissory notes issued by financial and nonfinancial corporations. Transaction volume for commercial paper exceeds the amount of any money market instrument other than T-bills. It is typically issued by large, credit-worthy corporations with unused lines of bank credit and therefore carries low default risk. Repurchase Agreement Repurchase agreements also known as repos or buybacks are Treasury securities that are purchased from a dealer with the agreement that they will be sold back at a future date for a higher price. These agreements are the most liquid of all money market investments, ranging from 24 hours to several months. Banker's Acceptance It is a short-term credit investment. It is a guarantee by a bank that payments will be made. The Banker Acceptances are traded in the Secondary market. Features of money market instrument Low default risk Short term maturity High marketability Successful investing is not about throwing money at any random investment. it requires taking investment education seriously and applying the careful analysis that can best be attended to by qualified and professional investment managers. When next you seek to invest in any segment of the market, please consult a financial adviser that can partner with you to help you achieve your investment goals. DISCLAIMER: The views expressed in this report are provided for information purposes only and are not to be considered as an offer or solicitation of an offer to buy or sell any financial instrument. The material herein is obtained from a variety of sources and we make no representation as to its accuracy or completeness. This material has been issued by GTB AM, which is regulated by the Securities and Exchange Commission. Further information on any security mentioned herein may be obtained by emailing: research@gtbasset.com.