Every month, Cowrywise drops a round up on mutual funds in Nigeria. It is always educative and written in simple English.

The October 2020 version was quite an interesting read. In October, a bond fund from Afrinvest—NIDF—earned 15%. Also, another fund—that invests in stocks—earned 12%.

However, I’ll just share details on the bond fund and why that happened. You can then read the full article, the link will be attached.
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Bond Funds: The Rain of Returns
Recently, funds that invested in bonds have had high performances. For example, the NIDF fund had a performance of 15% in October. Remember that performance is measured by the change in the unit price of the fund. If a unit costs ₦100 in September and ₦115 in October, the fund has gained ₦15 (15% of ₦100).

When entities, like the government, need money, they issue bonds. The initial price of the bond is determined by how much that entity needs, ₦100,000 for example. The issuer (entity lending the money) agrees to pay a set amount over an agreed period of time as interest.

If the agreed amount is ₦4,000 in this case, that amount, which cannot change, is called the coupon payment. However, there is another important term known as the yield to maturity (YTM). When a bond is issued, the YTM is the same thing as the coupon payment. So, for the above bond, the yield to maturity (YTM) is 4% (₦4,000 divided by ₦100,000). Here’s where things get interesting.

Since a bond is simply an agreement that qualifies one to receive coupon payments, it can be traded. If one chooses to sell the bond, bought at ₦100,000, many factors come into play but we’ll use a simple example to explain things. Take the YTM as the interest rate (currently 4%).

If the rate drops from 4% to 2%, the issuer still pays the agreed ₦4,000. But 2% of ₦100,000 is ₦2,000 so something isn’t right. To balance things, when rates drop the prices of bonds increase and vice-versa. Hence, at a 2% rate, the price of the bond jumps to ₦200,000 (2% of this gives us ₦4,000). The reality is more complex but this is a basic example.

Imagine an Ali bought the bond at ₦100,000. Now that the rate has dropped to 2%, he can sell the bond to John for ₦200,000. It doesn’t mean the government is borrowing more, the selling value just changed because of the rate drop. Think of this as buying an item and reselling for a higher or lower value.
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Read the full report here: https://cowrywise.com/blog/mutual-funds-october-2020/

Is it zero risk free on capital invested ?

No, bond and equity funds are medium and high-risk respectively. So, the capital can be impacted in some cases.

phrancys001:
Is it zero risk free on capital invested ?