What is a Retail Bond?

Companies are issuing bonds to be bought directly by the investor. The headline rates look enticing but retail bonds can be risky

Emma Wall 5 March, 2015 | 11:50AM
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Specialist lender ICG has today launched a retail bond offering investors 5% until 2013. For a minimum investment of £2,000 this attractive rate dwarfs what can be found on the high street – but investors should be wary of the differences between retail bonds and cash bonds.

It has now been six years since the Bank of England first dropped base rate to a record low of 0.5% and interest rates on cash have fallen ever since. With cash savings accounts no longer offering a real post-inflation return to savers, corporate bond funds have soared in popularity.

After funds became illiquid and expensive investors cut out the middle man and a slew of high profile retail bond launches from John Lewis, ICG, EnQuest and the London Stock Exchange itself attracted millions of pounds of investment.

In 2012 Tesco Bank was forced to pull its retail bond prematurely from the market. Demand was so high that after just two weeks, the issue had reached capacity - £200m - and was closed.

However concerns have been raised that inexperienced investors were unaware of the risks involved in retail bond investing - confusing retail bonds with cash bonds issued by a high-street bank or building society. 

A retail bond is an IOU issued by a corporation to an investor. An investor lends the company money, and in return the company pays the debtor interest on that loan. 

Unlike cash bond deposits, retail bonds are not covered by the Financial Services Compensation Scheme. The value of your investment can go down as well as up, although investors who bought at launch should have their initial deposit refunded in full as long as the company survives.

Retail bonds are a relatively new way for companies to raise cash. The London Stock Exchange only established a market for them in 2010 called the Order Book of Retail Bonds (ORB). This means retail bonds can be traded like shares. 

"Retail Bonds have struck a chord with those investors who want to cut out the fund manager middle man and are generally content to hold a bond with a decent coupon through to maturity," said Jason Hollands of financial planners Bestinvest.

"However, it is vital to know what you are doing as it is not as straightforward as being swayed by a well-known brand attached to the issuer and a juicy headline yield. These bonds are often owned by subsidiaries, so it is important to understand which bit of the business you are exposed to and where you will sit in the capital structure. This process has not been helped by the dearth of credit ratings."

Investors should also take care not to confuse retail bonds and mini-bonds. Mini-bonds are not listed cannot be traded on the ORB, are illiquid and must be held to maturity. 

Stockbroker Hargreaves Lansdown warned that unlike mini-bonds which need to be held until expiry some years later, retail bonds on the ORB can be bought and sold during normal market hours allowing investors the opportunity to both value and sell the bond.

Personal circumstances can change, so being able to sell your investment when you want and at a fair value should be paramount.

"The ORB has helped to provide essential liquidity to investors, but it also allows the bond to be held inside a SIPP and ISA wrappers,” said a spokesman for Hargreaves.

“I believe unlisted investments are inappropriate for the majority of retail investors. You are taking risks when lending your money to a company and I urge investors to think carefully about the suitability of mini-bonds before they buy."

 

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Emma Wall  is former Senior International Editor for Morningstar