Could investing in retail bonds be fatal?

A series of retail bonds from St Modwen, Workspace Group, CLS Holdings and Primary Health Properties in recent months shows that the retail bond market continues to grow apace.

While you might not have heard of these companies, with £2.5 billion raised since the London Stock Exchange (LSE) launched the Order Book for Retail Bonds (ORB) in February 2010, it is clear the search for income by retail investors is being matched by the desire of companies to find alternatives to bank loans.

The ORB is basically an electronic bond market for private investors and it offers two-way trading in more than 150 corporate, government and supranational bonds. A number of the issues retail investors bought by subscription have risen sharply since the ORB launch.

A Lloyds Bank 2016 5.5% issue (ie paying 5.5% and due to mature in 2016) now trades at just below 109p - a 9.25% gain since issue in March 2011 - while the Tesco Personal Finance 5.2% 2018 has risen by almost 7%.

Investor demand has seen many recent issues close their order book early due to strong demand. Most recently, the LSE's own inaugural bond on the ORB raised £300 million and had to close six days early.

Not without risk

However, there are dangers for small investors. Bonds are designed as long-term investments and those chasing quick price gains could get their fingers burned.

The LSE has risk warnings and glossaries on its website but the ‘bond' label means it is easy to get confused about the key differences in safety between high street bank investment bonds, guaranteed National Savings issues, corporate bonds and the retail bonds now advertised directly to investors.

"There is a danger that people get dazzled by the yields on offer. Most private investors need to tread carefully," says Jason Hollands, managing director of business development at wealth manager Bestinvest.

It is too easy to read across from the 3% yield you get on a cash ISA and be tempted by, say, 6% on a corporate bond, unaware this is not like a savings product, he says.

Some experienced bond market operators see many of the retail offerings as poor value. "I can't see any of the new issues as particularly attractive," says Mark Taber, a professional investor who runs While some of the better names are safe, the yields are uninspiring compared with existing bonds not on the ORB.

For example, Taber prefers Lloyds subordinated bonds (which would be repaid after other more ‘senior' bonds if Lloyds went bankrupt) at 9% to unsecured senior bonds from St Modwen at 6.25%. More broadly, many strategists see the fixed-income market as overpriced. The price gains seen so far may well not last.

"Fixed income funds have hoovered up lots of money in the past couple of years. Much of the fixed-income market doesn't look attractive," says Hollands. "Clearly, central banks are buying bonds, banks have been buying, insurers have been forced to buy them.

Most defined-benefit pension schemes have closed and are being de-risked by moving to fixed income, too." With everyone already aboard, "the easy money is over", he says.

That leaves very few attractive areas. One is high yield bond funds, where the income remains attractive. "We like Axa Global High Income because of its exposure to US high-yield markets," says Hollands.     

Taber agrees: "While investors are snapping up individual bonds at 5 to 6% yields, there are bond funds and exchange traded funds out there that offer higher yields and diversification, too." He notes that the Invesco Perpetual bond fund offers an income of 6%.

Rob Morgan, investment analyst at Hargreaves Lansdown, favours the Jupiter Strategic Bond, which he says has done a great job of dealing with interest rate shocks. "The distribution yield is 5.3%, though that can change because it is a strategic fund."

Retail picks

But what looks good if you wish to go for an individual retail bond?

"The Intermediate Capital Group 6.25% 2020 senior bond looks attractive at current levels," says Peter Day, a partner at wealth manager Killik & Co.

"It's an attractive rate of interest for a senior bond from an investment grade covenant. The bond is also trading at a fraction below its par value and so, unlike many other bonds, it won't see a fall in capital value as we approach maturity."

Day also likes the Beazley 5.375% 2019 bond. The Lloyds reinsurer is a robust company, with plenty of cash. "The diversity of its portfolio and the expertise of the group's underwriters have supported an unbroken 25-year record of profi tability," says Day.

Henrietta Podd, a director at investment bank Canaccord Genuity, is also a fan of the ICG bond, which she sees as outstanding value, trading just over par.

"The quality of that issue is such that we expect to see some capital gains, too," she says. She also likes the LSE bond, which she thinks is cheap for the quality, and the 7% issue from doorstep lender Provident Financial.