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Derivatives in Nairobi: “Yoghurt is a derivative of milk”

Friday August 9 2019

By BANKELELE
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The launch of derivative products, dubbed NEXT, at the Nairobi Securities Exchange (NSE) in July 2019, opens up an interesting new series of products for investors.

One of the main goals of derivatives is to manage risk amid volatile market prices, and they are widely used across the world today. The combined value of derivatives is estimated to be $544 trillion, globally, which is six times larger than the total global GDP of $88 trillion. But derivatives, if not monitored, may have a negative connotation for some investors, given their role in the last global financial crisis, as we saw with off–the-book transactions bringing down banks and economies.

However, the NEXT products that the NSE launched are simple standardized contracts that are transparent, valued and settled daily, allowing investors to take their profits and close loss positions. The trades are done through licensed brokers, with investors getting daily statement updates. The derivatives products also come with a Settlement Guarantee Fund and an Investor Protection Fund.

COMPARE WELL

Investors can now buy single stock futures for shares of Safaricom, EABL, KCB, BAT and Equity. Or they can buy an Index Future that tracks the NSE25 Share Index. Shares of British America Tobacco trade at Sh515 each and those of East African Breweries are Sh203 today. These prices are out of reach for many retail investors, but for a smaller amount, they can trade on what the future prices of these shares will be next quartet. Trading fees are 0.17 percent for single stock futures and for index futures, they are 0.14 percent, and this compares well with the 2 percent for trading shares. To trade single stock futures worth Sh1 million could cost as little as Sh1,700.

For the first time, investors can speculate on a share price dropping and take advantage of down market trends, not just the traditional buy low and sell high that has been the norm for shares. While ideally meant for institutional investors, derivatives futures can also be ideal for some retail investors such as young people, who may not want to sell the shares they inherited or to which they have a strong attachment.

Consider a Safaricom shareholder who may be concerned about the future of the company as it searches for a new CEO. The NEXT derivative products were launched on the same morning that the memorial service for Safaricom’s departed CEO Bob Collymore was broadcast across the world. Such a shareholder can, for a small price, purchase futures that protect their Safaricom investment without selling their shares.

TOO SMALL

Derivatives futures will help further integrate Kenya with international capital markets, becoming the second country in Africa, after South Africa to offer these products. While more offshore investors are keen on Kenya, they see it as a market that trades ‘only’ $3 - 10 million (Sh300 million – Sh1 billion) per day, and one that may be too small for the portfolios they are managing. Futures make it easier for them to manage their portfolios without having to move their money out of the country. Another aspect of derivatives will be that investors will be able to discover share prices better without having to buy or sell their shares.

At the NEXT launch, Derivatives Market at the NSE Chief Officer Terry Adembesa simplified them by saying that, “in simple terms, yoghurt is a derivative of milk." But while the costs to invest are smaller, and the returns are greater, so are the risks of trading through leverage. One banker said that retail investors need to understand that, while putting Sh10,000 gets them a futures exposure for Sh1 million, a five percent move against that position will wipe away 50 percent of their investment.

Twitter: @bankelele