Investors starved of dividends may consider retail bonds

The Covid pandemic has dealt a savage blow to those relying on the income from their investments; savings rates were already painfully low before the virus struck following the enduring low interest economy – and that got even worse when two emergency interest rate cuts took rates down to 0.1%.

Then, in a frantic attempt to shore up their balance sheets, companies across the spectrum started to slash dividends – ‘Why are companies cutting dividends?’
However, even though there has been a dearth of issuance of late, investors seeking income may consider retail bonds traded in the secondary market on the London Stock Exchange’s Order Book for Retail Bonds.

Retail bonds proved very popular when the exchange launched with some fanfare in February 2010 to service the increasing demand for fixed-income investments from retail investors, and the need for corporate to raise finance after the global financial crisis.

ORB offered investors to access attractive rates of interest offered by some of the UK’s biggest companies, from just £2,000; demand was so strong that few remained available for anything approaching their two week book building period.
 

‘investors seeking income may consider retail bonds traded in the secondary market’

One of the key aims of ORB was to develop an efficient, transparent secondary market in bonds for UK investors and to establish a primary market for distribution of dedicated retail bonds, opening up new sources of capital for companies seeking to diversify their funding.

As with any investment, the interest paid on the loan – the coupon – reflected the risk of the company defaulting, but those prepared to lend at the gamier end of the market were rewarded with rates that were pushing double digits.

A key attraction was the fact that those admitted to ORB were highly regulated and each issue was accompanied with a very high level of documentation and scrutiny; retail bonds come with a clear risk warning because they are not covered by the Financial Services Compensation Scheme (FSCS).

However, despite the collywobbles experienced by Premier Oil and Wasps Finance, to date, none has defaulted; Premier was trading as low as 35% in March of this year but clawed its way back to 84% on Fri 17^th July. Wasps has some work to do, closing as they did on 38% on Friday, and there is speculation that its 6.5% due 2022 bond may go to extra time.

However, as long as the company doesn’t go bust, bond holders will have 100% of their loan repaid as contracted, or renegotiated on more favourable terms. Wasps’ bonds are secured against the Ricoh Stadium, and bond holders rank highly when it comes to being paid. See more at Retail Bond Expert.

Bond markets were traditionally been the preserve of financial institutions such as insurance companies and pension funds; ORB facilitated the electronic trading of smaller bonds, so that DIY investors could choose individual bonds in the same way that they choose individual shares.

If you buy a bond at £100 (the starting price) it runs for an agreed number of years, paying you an agreed amount of interest on your loan, before paying you back in full.
 

Yield, the real ‘price’ of bonds

ORB was established to deliver liquidity, so that bond holders can either sell their bonds in a secondary market, or indeed buy more; during its life the bond price – the amount you pay to buy or receive to sell – will fluctuate, whilst the coupon remains constant.

Because of that, the yield – the coupon as a percentage of the price – fluctuates as well; when the bond price goes up, the yield goes down and vice versa.

Eg if you pay £100 for a bond paying interest of £6 a year, the yield is 6%; if the price fell to £50, anyone buying the bond would still get annual interest of £6, but at half the price, so the yield would now be 12%.

This is known as the running yield, and this is where investors seeking income should maybe consider further investigation.
 

‘Bonds that offer double digit returns may seem too good to be true; they are’

Bonds are rarely considered a source of capital growth, but popular bonds may trade over ‘par’ – meaning that investors believe it is worth paying a premium to achieve the income that is on offer.

If you buy a bond at £110, you will suffer a capital loss of £10 if you hold it until it is redeemed at £100; conversely, if you buy a bond trading at £90, you will enjoy a gain of £10 at redemption.

Known as the redemption yield, this gain or loss has to be taken into account when you are calculating what your overall yield will be if you go full term.

Those considering retail bonds for the first time will see some well-known companies to choose from; Tesco has a 6% bond due 2029, with a running yield of 4.6% and a redemption yield of 2.4% – not as advantageous as achieved by those that bought the initial offering, but better than many other options.

Wessex Water’s 5.75% bond has a running yield of 3.8% and a redemption yield of 1.4%; whilst these yields may not be astronomical you should be diligent in resisting the siren call of the many mini-bonds that will trip up the unwary. Bonds that offer double digit returns may seem too good to be true; they are, and FCA has now banned them being marketed to retail investors.

Because the market in some retail bonds is small, it can be difficult to get your money out if you want to sell before redemption unless it is at a lower price; remember, you can lose all your money if the company issuing the bonds goes bust because retail bonds are not covered by the FSCS.

For lesser-known companies, it pays to take a cynical view – did it only turn to the retail market because it struggled to raise money through larger institutional investors — and is there a reason why these institutions are not investing?

If you would like to see the full range of retail bonds that are available on ORB go to London Stock Exchange
 

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