Retail bonds: rare, risky, and sometimes rewarding

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. [↩]