Ask ii: Kenyan bonds yield 16% - should I have them in my portfolio?

A reader asks: “I am reviewing my investments and keen on government bonds due to their relatively low risk.

“I have been comparing UK bonds with other countries and if I’m not mistaken, Kenyan government bonds have one of the highest interest rates. Could you please advise on whether this would be a trustworthy investment? Or is the risk too high? The rates on offer seem to be twice that of other countries.

“Are there other government bonds you could suggest that are ‘essentially risk-free’, or safer, but with worthwhile returns?”

Sam Benstead, deputy collectives editor at interactive investor (pictured above), says: “When it comes to bonds, you're right to say that government bonds are generally lower risk than corporate bonds (those issued by companies), as governments can ultimately print more money to pay their debts and are therefore unlikely to default.

But that does not tell the whole story. For example, lots of developing countries issue bonds in US dollars, known as hard currency bonds, meaning that defaults are common as they cannot just print extra dollars.

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Issuing in their own currency also comes with foreign exchange risks – if you’re getting local currency but that currency loses value against the pound or US dollar, your actual return is going to be far less than you might expect. In addition, if there are economic troubles and it looks like a government will have to devalue their currency or print more money, then it is highly likely that the currency will also lose a lot of value against pounds or dollars.

The Kenyan government bonds you’ve identified, with yields at 16% for 10-year bonds, are issued in their own currency. So far this year, the Kenyan shilling has lost 17.5% against the pound, wiping out any returns you would have got in local currency.

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The risk should be evident in the yield you are getting. At 17%, this is about four times greater than the 4.5% that a 10-year UK bond pays you, or 4.6% from the 10-year US bond. A higher yield reflects higher risk, as investors are demanding a greater return for lending to a country or government.

In terms of adding Kenyan bonds to a portfolio, retail investors are unable to buy them directly, but they can own them via a portfolio of bonds picked by a professional fund manager. Emerging market bond funds are the ticket for investors looking for higher yields from less secure governments, but there is no guarantee the fund manager will pick Kenyan bonds.

Instead, they will take a view on the risks and rewards of each emerging market, and which type of bond and maturity length will make the best investment.

One emerging market bond fund that is part of our Super 60 investment ideas is the M&G Emerging Markets Bond Fund, a £1.5 billion fund managed by Claudia Calich.

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It has about one-third in dollar-denominated government bonds, one-third in local currency government bonds, with the rest in dollar corporate bonds, cash and local currency corporate bonds. In terms of geographic diversification, Indonesia, Malaysia, Mexico, South Africa and Brazil are its biggest markets. In sterling it yields nearly 6.5%.

You ask what government bonds are truly risk-free. The best answer for a UK based investor is gilts, which are the bonds issued by the UK government and promise to pay investors in pounds. You can buy them directly (see our guide here) or via a fund, such as the Super 60-rated Vanguard UK Government Bond Index.

Be aware though that investing in a fund exposes you to “duration” risk – which is the sensitivity of bond prices to changing interest rates. Even though the income is secure, the value of bonds can change. Read more about why here. If you buy a gilt and hold it to maturity, you can ignore changes in its price.