There's been a trend in recent years for some companies to offer 'retail' corporate bonds direct to the public, rather than the more usual route via markets. The Jockey Club and Nuffield Health being the latest examples. Although the interest rates on offer often look tempting versus savings accounts, are there catches? And should you take the plunge?.
What are corporate bonds
In simple terms an IOU from a company. In return for lending them money, they promise to pay you a fixed rate of interest for a fixed period of time and then repay the money you originally lent them (referred to as 'redemption'). You can read more on our Fixed Interest investments page.
Why do companies issue corporate bonds?
Because they want to borrow money. Alternatives include floating on the stock market (or, if they already are, issuing more shares) and bank loans. Issuing a bond can be attractive to companies who can't borrow money as cheaply from a bank and/or whose owners don't want to dilute their stakes.
How do retail corporate bonds differ from conventional?
The main difference is that retail corporate bonds are targeted at private investors, whereas conventional bonds are largely held by big institutional investors such as investment and pension funds. And while conventional corporate bonds may be traded via markets, some retail bonds forbid a change of owner, i.e. you must hold the bond until redemption. Retail bonds also tend to run over shorter periods of around 5 years, whereas 10+ years is more typical for conventional.
Why do companies issue retail corporate bonds rather than conventional?
Being cynical, companies turn to private investors when they think they stand a better chance of either raising the money or paying a lower rate of interest versus targeting intuitional investors. In fairness, the cost of issuing retail bonds is usually lower than conventional, so it can make more sense for companies to take this route when trying to raise more modest sums.
What happens if the company can't afford to pay me back?
You'll very likely lose some or all of your money. And, unlike savings accounts, such losses are not covered by the Financial Services Compensation Scheme (FSCS). The same holds true if the company can't afford to pay you interest. Bonds vary as to where they rank in the creditor pecking order if a company goes bust, but in general don't expect to get much, if anything back should the company become insolvent.
What are the risks?
The main risk is that company can't afford to pay you interest and/or repay the sum borrowed. As above, this could mean losing some or all of your money. The trouble is, it's very difficult to gauge the likelihood of this. Without having an in depth knowledge of the company and industry concerned you'll probably have to take a leap of faith based on the information within the bond's prospectus - far from satisfactory.
Rising inflation and/or interest rates are also a threat. High inflation will reduce the amount future interest payments and your capital at redemption can buy. While higher interest rates could make the fixed interest payments you receive look less appealing.
What else should you watch out for?
If a bond is non-transferable then you've no choice but to hold until redemption, bad news if you need to get your hands on the money meanwhile. If a bond may be traded then you could sell before redemption, but might get back a higher or lower amount than your original investment depending on its market price at that time.
Some retail bonds include a gimmick within a high headline interest rate. For example, the Jockey Club bond quotes 7.25% annual interest (before tax), but 3% of this is paid via credits to spend at the races - not much use unless you're a keen racing fan - and 4.25% a year sounds far less appealing.
Never invest in a retail bond without reading the prospectus cover to cover. Yes, it's mostly dull as dishwater, but it may highlight specific risks or issues you'll otherwise miss. And keep an eye out for potential liabilities that could hit the company in future, for example debts that need repaying or a final salary pension scheme in deficit.
Does the interest on offer outweigh the risks?
This is something you'll have to judge yourself. However, if the retail bond term is 5 years then compare the interest offered to the rate on a 'best buy' 5 year fixed rate savings account - about 3% at the time of writing. The savings account is 'risk-free' (in so far as the first £85,000 is covered by the FSCS if the bank can't repay you), so any bond interest in excess of that is effectively the 'premium' you're getting to take some risk.
In the case of the Nuffield Health retail bond paying 6%, you're getting an extra 3% a year to compensate for the potential risks. Some might find this acceptable, others probably not.
Should you buy retail bonds?
Never buy them as a direct alternative to a savings account - there are risks involved and you could lose some or all of your money.
Otherwise you'll need to weigh up the risks versus the potential return on offer. And this is perhaps the big stumbling point. Most private investors, me included, would struggle to gauge the potential risks with any degree of accuracy. Without the ability and/or time to thoroughly understand a company's business, accounts and bond terms and conditions, investors (to varying degrees) end up having to take a punt.
On balance I don't think retail bonds are necessarily bad (each must be judged on its merits), but if one of these bonds does go belly up in future we can expect a lot of investors moaning they didn't have a clue what they were buying!
Read this article at http://www.candidmoney.com/articles/272/are-retail-corporate-bonds-a-good-deal
