Exploring commercial papers for investment portfolios

The Nigerian economy continues to witness high volatility since the past year, with increasing high inflation, fluctuating foreign exchange rate movement, and continuous tensions arising from insecurity challenges in all regions of the country.

Investors are constantly seeking investment strategies and the right combination of asset classes to achieve their portfolio objectives amid these uncertainties. Commercial papers (CPs) provide diversification benefits, liquidity, and attractive returns for low- to medium-risk portfolios.

Most commercial papers are unsecured and issued by large creditworthy corporations to fulfil short-term funding requirements. These instruments have maturities ranging from a few days to 270 days.

In Nigeria, most commercial papers are issued for 90, 180, or 270 days and are sold mostly to institutional investors. Some notable issuers are Dangote Sugar Refinery, Flour Mills of Nigeria, Nigerian Breweries Plc, Julius Berger Nigeria, MTN Nigeria, and Sterling Bank.

The market for CPs is regulated by FMDQ Group Plc, which also provides the quotation, trading, and valuation services for the securities.

In 2023, an estimated ₦1.5 trillion by 56 corporates was raised by corporates in the CP market, and since the first CP issuance in the Nigerian market, there has been an extremely low level (<1% of the total size of the market) of default of commercial papers.

Commercial papers are increasingly appealing to a wider investor base within the investment community in Nigeria. At present, mostly institutional investors, as defined by regulation, can assess the primary market for CPs.

Retail investors may obtain exposure to the market through mutual funds and other investment products that are provided by asset/fund managers. Major participants in the CP markets today include pension funds, money market/mutual funds, and insurance companies, as the market has proven to provide liquidity and attractive risk-adjusted returns to investment portfolios.

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Liquidity is the foremost attractive feature of commercial papers for investors as they seek to provide for their portfolio cash demands.

Since the inception of the market, treasuries have been and continue to be the major source of liquidity for many portfolios as regulatory liquidity requirements for financial institutions continue to support their prominence. Bank placements have also played a dominant role in providing liquidity, despite their relatively low yields.

Commercial papers offer investors liquidity in addition to the advantage of a risk-adjusted return, and unlike placements, the increasing volume of trading activity in the CP market provides flexibility across various tenors with little transaction costs, making them an attractive alternative for return-seeking portfolios in an inflationary environment.

Considering investment management strategies and tactical asset allocation, commercial papers have proven to be beneficial in adequately incorporating short-term market swings and current economic conditions.

Owing to their short-term nature, CPs are positioned to adequately and promptly capture movements in yields as well as other market and macroeconomic information, making them suitable for tactical asset allocation.

Commercial papers present a spectrum of benefits for investors, encompassing liquidity, high quality, attractive returns, diversification, and investment management advantages. As the market deepens, commercial papers will continue to offer benefits to investment portfolios and proffer options for different investment management strategies.

Ekanem Etim is the Vice President & Team Lead of capital Markets at DLM Advisory, where she specialises in providing investment banking and financial advisory services. With extensive experience in securities issuances, Ekanem provides valuable insights into market trends and financial securities in the market.