Top tips for investing in retail bonds

With stock markets proving unpredictable and cash deposits offering poor rates of return, investors are turning to inflation-beating retail bonds in their search for income. These bonds – a way for companies to borrow from the investing public – are proving so popular that the latest bond offered by Icap, the interbroker dealer, was forced to close early due to over demand. This followed a flurry of high-profile retail bond issues by companies such as National Grid, Royal Bank of Scotland and Primary Health Properties (PHP). The latter raised £75m in its retail bond offering last month, reaching its maximum target a week earlier than expected. The 5.375 per cent coupon, or interest rate, is paid twice yearly for seven years. Earlier this year, Tesco Bank was forced to take its latest corporate bond off the shelves two days early. The bond, which offered a yield of 5 per cent, attracted £200m from investors in two weeks. But experts warn that these retail bonds, a type of corporate bond designed for ordinary investors, do not carry the same guarantees as savings accounts. Mark Glowrey, head of retail bond sales at Canaccord Genuity, outlines five things investors need to consider if they are thinking about buying retail bonds. 

1. Know what you are buying

Unfortunately, there are numerous products and instruments described as “bonds” which are available to private investors, including fixed-term bank and building society deposits and fixed-term packaged investments from insurance companies. Such investments can be judged on their individual merits, but for the purposes of this discussion, let’s stick to the definition of a bond as used within the financial markets – namely a tradable fixed coupon security with a set redemption date. Some companies, such as the Mr & Mrs Smith Hotel Group, have been arranging “C2B” (consumer to business) loans which they are also calling “bonds”. Glowrey argues that these are not recognisable as such, given that they are not transferable and thus untradeable. 

2. Know who you are lending money to 

When you invest in a bond, you are lending money to a company. Make sure that you are comfortable with that company, its management and its business model. Credit ratings can be an aid, but there is no substitute for “DYOR” (Do Your Own Research). Also, identify where the bond sits in the asset class pecking order. Bonds sit above equities in the ranking, giving the bond holder a prior claim on a company’s assets. But, there is a ranking within various classes of bonds. Secured debt is the highest ranking and will usually have a direct charge on the company’s real estate should anything go wrong. After that comes senior debt, the most common form of bond – which is where retail bonds sit. Below this is the higher-risk subordinated debt, such as the widely held building society Permanent Interest Bearing Shares. The latter typically have higher yields to compensate investors for the increased level of risk. 

3. Think about the “yield curve” 

The relationship between short-term and long-term rates is known as the yield curve. Shorter-term rates are super-low because they are linked to the Bank of England base rate, which is stuck down at 0.5 per cent That means that short-term bonds also tend to have fairly low yields. However, investors willing to lend for longer periods of time can achieve better yields – at present, 5 per cent is being offered on investment-grade bonds in the 5-10 year maturity bracket. But be cautious of extending your average maturity too long. If interest rates go up in the future, holders of very long-dated bonds may be stuck with investments that are offering below-market coupons. 

4. Research the secondary market. 

Most investors buy bonds at launch, and many hold them to maturity. However, once issued, bonds, like shares, can be freely traded and the new class of retail bonds now being launched on the LSEs ORB platform can be easily dealt with through stockbrokers. Consider that bond holders have an advantage over equity holders – the realisation of their investment can be achieved through two methods; either holding the bond to maturity or by selling in the market. Equity investors are always beholden to the future market price when they want to sell.

 5. Tax 

When investing, the quality and risk/reward of the investment should be the first consideration for any consumer, and any tax consideration secondary. However, bonds have a few useful benefits from a tax perspective. Firstly, bonds pay their coupons gross which means no tax has been taken off. This means that UK investors can hold these bonds in an individual savings account and get the returns tax-free.