21st Aug

Fork 'andles

Retail Bond Expert has been in the vanguard in calling for adequate and transparent documentation in support of issues on the Orderbook for Retail Bonds (ORB) and in ‘Caveat Emptor – Mr Bond Urges Caution When Purchasing Retail Bonds’ (Retail Bond Expert 7th July) considered the characteristics and relative attractions of the various types of products that are increasingly being generically referred to as retail bonds. At the end of May, Federal Reserve chairman Ben Bernanke prompted a sell-off in both bond and equity markets when he said the central bank would look to ease the pace of its quantitative easing programme if the US economy continues to strengthen as expected. As a result a number of analysts called the end of the bull market in bonds which dates back to the 1980s and urged a reduction in exposure to long term government debt.  

"Quantitative easing programme to ease off in the US"

Retail Bonds issued on the growing ORB exchange are often seen as a viable alternative for investors looking for fixed income investments but with reduced duration risk and a degree of insulation from central banks’ monetary policy. Since its launch in 2010, ORB has hosted 38 corporate bond issues and raised £3.4bn from yield-hungry small investors. Key to the development of the market has been the ability for retail investors to buy bonds in denominations of £100 and typically with a minimum investment of £2,000, which represents a departure from UK PLC’s previous unwillingness to issue debt in denominations of less than £50,000 – effectively ensuring that only institutions were able to buy in. This move paves the way for the retail bond market in the UK to emulate the success of the flourishing sectors in Germany, France, Italy and Spain; ORB offers investors the ability to choose from a wide range of issue, with most trading above par in the secondary market and no defaults to date. However, investors are advised to ‘measure twice and cut once’ when considering a purchase of retail bonds, and most importantly to understand precisely where their debt stands in the capital structure of the issuer should it run into difficulty; perhaps even more fundamentally, precisely what the issuing entity is.

"Measure twice and cut once"

One of the key factors in the success of recent retail bonds launches has been the trust and brand recognition engendered by the issuer, but some commentators point to the collapse of Enron and suggest that those that do not learn the lessons of history are doomed to repeat it.   When US energy giant Enron collapsed in 2001, investors holding bonds issued by the holding company lost everything, while bonds issued by the operating company were safe; it is feared that retail investors purchase bonds because of their knowledge of, and perhaps trust in the brand of the issuer, but without understanding the precise nature of the issuing entity.

For example, National Grid and Severn Trent have each issued retail bonds backed by cash flows from their holding companies, rather than the regulated operating companies that stand behind many of their institutional bonds which are limited in the amount of debt they can issue, thereby reducing the risk to lenders. Severn Trent says that under the UK’s prospectus directive, retail bonds can be issued only by entities that publish semi-annual accounts in line with the rules for listed equities and that its holding company, Severn Trent plc, is the only group company to make up half-yearly accounts. National Grid confirms that the retail bond it has issued is by the parent holding company, National Grid plc and that it offers a range of institutional bonds with some issued by holding companies and others by regulated operating companies. Tesco Personal Finance has issued three retail bonds, but these are issued by the banking subsidiary rather than the retail giant, and there is concern that retail investors are basing a purchasing decision upon their emotional attachment to the parent company rather than an objective appraisal of Tesco Personal Finance as a worthy recipient of their loan. Jason Hollands, MD of Bestinvest says ‘It might have a good name on the tin but the debt may be issued by an overseas subsidiary. There have been some high quality issues, but often people don’t realise that the issuer is an offshore subsidiary’ Mr Bond urges would-be investors to ensure that they fully understand who they are lending to, what protections they are afforded and where they sit in the debt hierarchy of the borrower.

"What's in a name? That we call Tesco Personal Finance, by any other name would smell as sweet"

As ever investors should seek advice appropriate to their level of knowledge and investment experience before purchasing a retail bond, and ensure that they understand the risk to which they are exposed. However attractive guaranteed returns of anything up to 6% p.a. may be in this low income environment, some observers still believe that retail investors get a poor deal in comparison to the institutions. Stephen Snowden of Kames Capital cites the recent example of subprime lender Provident Financial where retail and institutional bonds were issued by the same entity, but with the retail version paying 7% and the institutional 8%. ‘There is a very good reason why companies go direct to the consumer and it’s because the companies’ benefit. They can sneak out a bond with lower protection or they can get it away with a lower yield’ cautions Snowden In the institutional sector, bonds issued by regulated entities are typically granted a higher credit rating, and this adds grist to the mill in Retail Bond Expert’s drive to achieve a ratings system for retail bonds.   

There are encouraging signs that levels of information in support of retail bond launches are improving - the prospectus in support of the recent launch by Helical Bar was the first to be approved by the new Financial Conduct Authority and in line with its focus on retail investors, both the format and the language were revised so they were more digestible. Significantly in light of the above, many prospectuses now include diagrams of the corporate structure. Those nervous about direct exposure to a subprime company like Provident Financial may find that the diversification offered by a bond fund delivers a more acceptable risk profile and whilst the annual management fee may initially make this form of investment appear more expensive, the fund may have been able to purchase its bond more cheaply than the individual could, and add the safety of a spread of risk. As ever, if you have any thoughts or comments , Mr Bond would welcome your feedback – did you know that your Tesco 5% was not backed by the nation’s favourite grocer?  


Posted on 19/10/2013 23:19:02

The interest rate on your bonds will stay solid as long as that is the type of bond you pshrcaued. Some bonds have step rates or zero coupon rates. However, it sounds like you are buying a regular bond that has a fixed percent with a fixed term. Each day, the market price of the bond fluctuates based on its selling and buying values. As long as you hold it to maturity, none of this matters. The only down side for a bond these days is the solvency of the company. Like Lehman Bros. Their bond holders just received a notice that they will get $600 from a $5K investment. Bonds are a fab investment right now. Best investment is a mid term bond that would be held for five years. You can get some good ones out there with a term of five years with a 7 plus percentage return. Anything over five years, plan to hold them for a while. Eventually interest rates will go up and if you need to sell your bond, you may not get the full value.

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