This article by new contributor Longshore Drift explains why he was drawn to the investment potential of retail bonds.

Even against the backdrop of an ever-shrinking market for new London listings, retail bonds don’t get much love.

Few retail investors look beyond gilts and Premium Bonds – and bond funds of course – but loans to the chancellor or to ERNIE aren’t the only option for small savers.

Like their more popular bond brethren, retail corporate bonds represent a loan of your money. In this case to a company.

But instead of the tiny chance of a prize each month that you get with Premium Bonds, with retail bonds you’re paid a ‘coupon’ – an interest payment – typically twice a year.

There is also a redemption date, which is when the bond is redeemed and you get your original investment back. Albeit slightly gnawed at by inflation in real terms.

• See Monevator’s guide to bond jargon for more terms to know

Unlike with Premium Bonds, there’s no app prize porn to gee you up with a slow-motion video of someone popping the champagne to celebrate a life-changing £25 win.

There’s also no guarantee you’ll get your money back!

Slim pickings among retail bonds

Beyond that inherent risk, the main problems I see with retail bonds is there are very few of them around and the returns look unremarkable.

The London Stock Exchange (LSE) currently lists 121 ‘retail bonds’. Of these, 91 are gilts. That leaves just 30 corporate retail bonds, covering loans to 19 different companies.

These firms range from big names like GlaxoSmithKline, GE, and BT, through to lesser-known outfits like Belong, a charity that operates what it calls care villages for people with dementia.

Returns on offer are moderate, though they might at least be a stable form of income. Retail bonds currently offer coupons as low as 3.5%. Note though that redemption yields are higher if you hold them until maturity, since many retail bonds trade below their face value. By this measure most yield 5-6%.

To summarise: riskier than cash and probably lower returns than a portfolio of equities.

An easy pass?

For most, perhaps. But for more adventurous investors out there: how about earning 12% a year as your reward for nosing through the odds and sods bin of British securities?

A risky punt for income investors

As an exception to the moderate returns rule, consider International Personal Finance (ticker: IPF3), which offers a tasty 12% coupon.

This retail bond was issued by – you guessed it – International Personal Finance (IPF). It’s a doorstep and digital consumer lender that operates across the EU and beyond.

Now, if you think regulated high-cost short-term credit is not to your taste, that’s fair enough. I’d hazard a guess that their products are not aimed at the typical Monevator reader. 

But perhaps you might research the alternatives for those people with an immediate need for short-term bridging cash?

You could find yourself glad that firms like IPF provide an option for those with, well, fewer options. 

Reader, I bought some 

When IPF3 first appeared with its roof-thumping coupon, more experienced people than me greeted it skeptically.

One article of the time was peppered with warnings like: “Think hard before putting your money into such a bond. If something sounds too good to be true, it probably is.” 

But I’m happy to say I didn’t read that sensible article until after I had bought the bond.

Hindsight remains a wonderful thing, and with its benefit I can now say that IPF3 has since traded on around an 11% premium1. Adding to my comfort, IPF is a consistent payer of dividends on its shares.

IPF3’s huge premium is perhaps a reflection of two things: the market’s confidence in the coupon, and the scarcity of that kind of return from retail corporate bonds.

What squared it for me was that I have some knowledge of its sector – and that someone I knew with a far deeper understanding than me had bought some, too.

Why such a high coupon? Well, short-term lending is a deeply unfashionable sector. Ratings agencies don’t much like IPF3, nor IPF’s historical exposure to regulatory change.

Would I buy a bond paying that kind of coupon in an industry I didn’t have some level of understanding of? Say, commercial property?

No chance. I wouldn’t touch it with yours. For me, I needed to feel I understood the basic mechanics of the business to have confidence to invest in it.

Just like when stockpicking equities, you must do your own research.

Behold the ORB!

Intrigued enough to dig deeper? Here’s some more things to know about retail bonds.

Corporate bonds used to be reserved for those with big chunks of cash. They were allocated in lumps of £100,000. So strictly for institutions and high-rollers.

However since 2010 retail investors have been able to get a slice of the (slow-moving) action with retail bonds, which are trade on the mystical-sounding ORB – a.k.a. the LSE’s Order Book for Retail Bonds.

And the good news for us is you can trade them in lots as small as £100. 

New bonds soon get dirty

Retail corporate bonds are typically issued at 100p, which makes tracking their fortunes easy.

If the bonds are bought and sold above that price they are said to be trading ‘above par’. This means that investors see the income from the coupon as worth paying up for, even though they will face a capital loss on the principal they invested in the bonds when they reach redemption, if they still hold by then.

The flipside of this is when bonds trade at a discount. Most of them do.

Adding to the fun, when you buy or sell retail bonds with some coupon due, a premium is paid on the listed price to compensate the seller for any accrued coupon. This represents the difference between the ‘clean’ and ‘dirty’ price. 

And yes, as this implies you can trade them like equities. But more likely you’ll hang on to them, take the coupon, and hope to get your principal back at redemption.

Being bold in this game means ‘Buy low, and then later sell high at par’.

Dividends are your coupon canary in the coal mine

Many companies that offer retail bonds are also listed businesses with a long history of paying dividends.

Given bond coupons for bondholders are generally prioritised over dividends to shareholders, shrinking dividends can be an early warning sign if things are looking dodgy – without you needing to understand a balance sheet inside out. 

The (marginal) case for retail bonds in your portfolio

At times of poor returns from bank savings, retail bonds can offer a halfway house between cash and equities. Predictable like a fixed-term savings account, in terms of income, but with the prospect of higher returns than you would get with cash. 

This might be an attractive proposition for someone looking to move money away from, say a reliance on a global tracker that has roller-coastered its way through the early days of the Trump administration, but who is unimpressed by interest rates on cash.

However we can’t avoid the fact that buying a corporate bond, like investing in particular company’s equities, inevitably massively concentrates your risk.

Also nobody from the Finance Services Compensation Scheme will be standing by with a blanket and a cup of tea if your retail bond goes wrong.

In my opinion though, as an alternative to holding cash some exposure to retail bonds could be rewarding.

Lukewarm compared to the white heat of the S&P 500? Far riskier than cash? Concentration risk?

Sure. But I think there’s a place for retail bonds in more sophisticated investors’ portfolios. Especially if interest rates are in retreat.

• See this ancient article by The Investor on building a retail bond portfolio

1. That is, the price you get for it if you sell it in the market is 11% above the face value of the bond. [↩]

When do fund fees drop so low that it’s not worth the hassle of switching to a cheaper fund?

Naturally that’s a personal decision. But there does come a point when sweating the difference between two cut-rate options has a vanishingly small impact on your future wealth.

That point arrives when the cost of a fund in pounds falls so low that even moving to a rival that’s half the price makes little material difference.

The numbers bear out this apparent heresy – and I say this as someone who had it drilled into them that investment costs were to be crushed like infidels on the wrong side of a holy war.

What’s the cost in raw cash money?

To see how the diminishing returns of fee-relief set in, we have to assess fund costs in cash terms, as opposed to comparing the relative difference in their ongoing charge figure (OCF) percentages.

For example, let’s compare the fate of £10,000 invested in three funds for 30 years. I assume each fund returns 8% a year before these fees:

• Fund A’s OCF is 0.05%
• Fund B charges 0.25%
• Fund C whacks its investors for 1.25% per year

Fund B is fives times cheaper than fund C.

Similarly, fund A is five times cheaper than fund B.

However switching from fund B to fund A matters much less to your final investment outcome than making the leap from fund C to fund B would.

The Final investment pot line in the table below shows this clearly:

Fund	A	B	C
Fund OCF (%)	0.05	0.25%	1.25%
Fees paid year one (£)	5	25	125
Final investment pot (£)	99,238	93,868	70,963
Total fees paid (£)	1,388	6,758	29,663

Your final pot is 32.3% bigger if you invest in fund B not fund C. That’s huge!

But your final pot is only 5.7% bigger if you invest in fund A instead of fund B. Not so huge. 

That 5.7% extra is useful for sure. But it’s probably not worth Force-choking your fund manager like Darth Vader whenever a competitor undercuts them by a basis point.

The fund fee drag factor

Ultimately, it’s the high cost in pounds of fund C that exacts an extreme toll, relative to the 8% per year earning power of your investment.

For example, all three funds above earn £800 on the £10,000 invested in year one.

But the proportional amount of that return trousered by the fund managers is very different as the fees scale:

Fund	A	B	C
Fees paid year one (£)	5	25	125
Fee deduction from £800 year one return (%)	0.63	3.13	15.63

Fund C swipes nearly 16% of your return in year one! That clearly hurts, and so reducing that loss to just 3% by running into the arms of fund B is well worth it.

However jumping ship again to fund A is much less of a win as the charges rush towards zero.

That’s because it’s the absolute difference in pounds that we care about. Not, ultimately, whether one fund is half the price of the other.

Metaphorically-speaking, you might be incentivised to drive an extra mile down the road to save £10 on filling up your car. But you may not bother for a quid off. Especially if there are plenty of other ‘to dos’ in your life that are screaming for attention.

I guess that the point of indifference to savings is related to the gallingly minor happiness boosts we feel when spending on upgrades.

For instance, having a phone is a very useful thing. But buying a new phone with a slightly better screen resolution? Who cares?

The absolute difference is barely detectable.

Running the numbers

Next time you want to see what difference fund fees could make, you could try using an investment fee calculator like the one offered by Dinky Town.

Play around and you will find that:

• The lower your returns, the more fees matter.
• The longer your time horizon, the more fees matter.
• Fees matter less the more your outcome relies on future monthly contributions, as opposed to your current investment balance. That’s because negative compounding has less time to do its dirty work.

More mathematics

Do a breakeven analysis when selling an unsheltered fund exposes you to capital gains tax.

Transaction costs and time out of the market can also potentially swamp tiny savings. (That’s much less of a consideration if you’re just switching between ETFs with minimal spreads.)

Once index tracker fees shrink low enough, tracking difference and variations in underlying holdings may become more decisive factors when weighing up two alternatives.

Spot the difference

You can get a grip on tracking difference by plotting a fund against its comparison index using Trustnet’s multi-plot charting tool.

Our fund comparison post explains how to add the correct index to your chart. (See The impact of the index section of the article.)

Tracking difference is a useful gauge of management efficiency. It’s a positive sign if a fund provider’s trackers typically cling tightly to the index. That’s what we want, so sometimes I’ll check a sample of a provider’s products to help me decide if that’s something they’re good at. 

By contrast, the future variation in returns caused by rival funds’ divergent holdings is a crapshoot. The difference can be wild in sectors like gold miners or commodities, or marginal in categories like global tracker funds.

Past returns may tell us that a particular index configuration is flawed, or it could just be that some component suffered a losing streak that might flip into a hot hand at anytime.

Sometimes, if you dig deep enough, you can uncover reasons to believe that certain indexes or products contain inherent weaknesses.

Vanguard LifeStrategy 100’s home bias counts against it so long as the US stock market reigns supreme over the UK’s, for example.

Meanwhile, synthetic S&P 500 ETFs consistently outperform their physical counterparts due to an in-built tax advantage.

A cost of doing business

Transaction costs are another factor to investigate if you want a fuller picture. They can be as large as the OCF in some markets.

However these fees tend to fluctuate a lot and are hard to pin down.

Hargreaves Lansdown is a good source to research transaction costs. Navigate to a fund’s web page on the Hargreaves’ site. Go to the Costs section and you’ll find transaction fees nestling in the Investment Charges dropdown menu.

Your mileage may vary

Costs do matter. The difference between a 0.25% and 1% OCF fund is significant. But the wealth leakage from a 0.25% fund versus cheaper models is much less of a biggie.

After all there’s only so much time in the day. Beyond a certain point, relentlessly chasing fee reductions is more Captain Ahab than Martin Lewis.

By all means keep optimising until you’ve had your fill.

But if you’re losing the will, then take heart. If you’re passively invested in a portfolio of low-cost index funds and ETFs then you’re already well ahead of the game.

Take it steady,

The Accumulator

What caught my eye this week.

I used the Current Account Switch Service (CASS) for the first time a few weeks ago.

As the founder of a financial blog, I guess this might make me sound like one of those presenters who sheepishly admits in the middle of a TV makeover show that they’ve never held a paintbrush.

It’s not quite that bad. While I confess I still have my student bank account – for all the good such loyalty did me when I needed a chunky mortgage – I’ve always had a couple of other accounts on the go for their higher rates or perks.

There must have been a dozen since the Egg days. It’s just I’ve always done any switching between them for myself.

I’d read enough to know the CASS would probably work fine. But it was still nice to hear my girlfriend’s confidence as a several times user of the service.

Sure enough, the cash and scheduled payments appeared to be transferred away from my dying Santander 123 Lite account in good time, like those diplomats being airlifted off the roof of the US embassy in Saigon in 1975.

And as best I can tell a month later, they were. Everything seems to have gone super smoothly.

The snag

What was surprising though was to get a ping from Monzo this week saying my credit rating was down with one of the reference agencies.

Quite the plunge, too. From nearly 1000 to a good-for-normies 800.

Huh. Nothing else has changed with my personal finances recently except for this switch. And as I say it wasn’t even from my oldest bank account.

The move did see me close down the account that has handled the lion’s share of my direct debits for years though, due to it once touting excellent cashback. So I presume the agency’s computer was alerted to this and cried “shenanigans!”

It’s no biggie. The downgrade doesn’t hurt anything except my sense of perfectionism. The other agencies haven’t raised an eyebrow, and I presume this one will come good soon enough, too.

That said our recent post on stoozing did get me thinking I should ramp up my interest-chasing efforts again, just for the fun of it.

Also now I’ve used the CASS, it’s easy to envisage swapping around a dedicated switching account with a couple of non-core direct debits attached, just to collect the bonuses.

Such cash freebies would be welcome enough. But to be honest they wouldn’t move the dial much at my stage of the game compared to the faff involved.

However this whole episode has been a good reminder of how useful hands-on experience is. I write much more about investing than money matters, but still – perhaps I should keep a toe in these waters? Just like those TV presenters might want to have a bash at doing up their spare room.

Whether the credit agencies would endorse such resurgent vigour is another question!

Have a great weekend.

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