By Chijioke Ohuocha

LAGOS (Reuters) — Fund managers in Nigeria have been moving cash into government bonds this year and selling riskier assets, dampening a stock market rally as uncertainty over forthcoming elections and growing security risks hit demand for equities.

Nigerias main stock index returned 44 percent in dollar terms in 2013, thanks to a stable naira currency, making it one of the best performing African equity markets. The gains boosted its allure as an investment destination, attracting foreign investors and pension funds.

But Africas largest economy has since suffered currency weakness, down almost 3 percent this year, and is beset by uncertainty over upcoming elections, coupled with Aprils abduction of over 200 schoolgirls by Islamist group Boko Haram.

That, plus a string of bombs across the north and centre of Nigeria — including three in the capital Abuja — blamed on the militants, have brought it home to many foreign investors that Africas top oil producer faces grave security problems.

Nigerias stock index has struggled to rise much above a 43,000 point resistance level. It is up 4 percent this year, lifted largely after index compiler MSCI reweighted Nigeria, making it the second biggest in its frontier index after Kuwait.

The stock exchange in the first quarter said that local participation in the equity market had waned as domestic buyers composed mainly of retail investors stayed wary of stocks, which fell more than six percent during the period.

Once elections are over, there will be greater clarity. The safest thing to do at this point is to buy bonds, said Adeniyi Falade, managing director of Crusader Sterling Pension, which manages over 100 billion naira ($616 million) in pension funds.

Asset management firm FSDH, which manages over 50 billion naira, said it viewed the equity market as overbought and had cut its exposure in favour of treasury bills.

At the end of March, pension funds had 13 percent of industry assets worth 4.2 trillion naira invested in equities and 68 percent in government bonds, data from the pensions regulator showed. Pension funds can invest half of their portfolio in stocks.

SECURITY RISK

Nigeria rebased its GDP in April, pushing it up to $500 billion and enabling it to overtake South Africa to become the continents largest economy, although it also slashed growth estimates for 2012 and 2013.

But a spike in violence by Boko Haram in the same month underscored the growing instability faced by Nigeria.

It had previously had a muted impact on financial markets, as attacks had been largely restricted to the north, but this year they have radiated towards the centre again to cities such as Jos and the capital Abuja.

Falade said fund allocation to bonds had risen to 70 percent in the third quarter as portfolios took less risk, a situation he expects to continue until after elections in February 2015.

Sub-Saharan Africas second-biggest stock index witnessed a one-off rally to hit a four-month high in June after MSCI increased Nigerias weighting to 19 percent, from 12 percent, in its frontier market index.

There is more exposure to fixed income. Our current allocation is 80-85 percent, said Micheal Oyebola, managing director at FBN Capital Asset Management, whose assets under management rose to 32 billion naira in under a year, from 4 billion naira.

We have found out that most of our clients are risk averse, he said, adding that yields on treasury bills were attractive at around 12 percent for the one-year note, as against a 5 percent dividend yield on stocks.

Nigeria has taken advantage of the liquidity in debt markets to raise 4.37 trillion naira in treasury bills in the first quarter as yield hungry-investors sought to lock-in rates.