What are retail bonds and are they worth it?
Interest rates may not have been cut in recent months, but with inflation expected to rise in response to the Iran war fallout, it's getting harder for savers to generate real returns on their cash without taking on excess risk.
Retail bonds offering fixed returns and inflation-busting interest rates are undoubtedly eye-catching – but are they a wise place to put your money?
This month Secured Fixed Income was offering 7.5% interest on a three-year bond, with a minimum investment of £1,000. The money raised is used in its lending activities. It said the fixed return offered “clarity of outcome in a changing interest rate environment”.
That certainly seems appealing at a time when the top savings accounts are paying interest up to 4.75%. But Brian Dennehy, managing director at Fund Expert, warns: “Any product offering an interest rate greater than cash in the bank involves risk. The greater the difference, the greater the risk. The difference here is substantial, so the starting assumption must be that the risk is substantial.”
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What are retail bonds?
Bonds are essentially an IOU from a company, which borrows money from investors to fund its spending. Retail bonds are those that can be sold directly to individual investors, as opposed to institutions like banks. Under the bond, the company agrees to borrow for a set period, during which time it will pay a set rate of interest (known as the coupon) and your original capital back at the end. The main risk for investors is that the company defaults, which means it is unable to pay the coupon or to return their investment.
There are two types and, confusingly, neither are actually called retail bonds.
Those listed on the London Stock Exchange (LSE) are, as of January, referred to as access bonds. Designed to Financial Conduct Authority (FCA) criteria, the LSE says these bonds are simple, transparent and appropriate for retail investors. They also have much lower minimum investment thresholds than other corporate bonds, often from £1 rather than the £100,000 or more that traditional corporate bonds tend to require.
A bond from the energy company EnQuest paying 9% (five-year bond at issue, maturing October 2027) is currently available, as is a ten-year bond from RCB Bonds, which raises finance for charities, paying 3.5%. The ten-year bond matures in 2031. Investors can buy these bonds through investment platforms such as Hargreaves Lansdown and AJ Bell.
The other type of retail bonds are known as mini bonds. These are typically higher-risk, unregulated and, unlike an access bond, cannot be bought or sold but must be held to maturity.
These had something of a heyday after the 2009 financial crisis – with mixed success – but are rarer today. Examples include the Hotel Chocolat retail bond, which was launched in 2014 and paid investors in chocolate rather than cash, and the Burrito Bond launched by Mexican fast food chain Chilango in 2018, which promised interest of 8% (as well as one free burrito a week) but collapsed in 2020.
Perhaps the highest-profile of these was a mini bond from the investment firm London Capital & Finance, which promised interest of up to 11%. An estimated 11,600 investors lost a combined £237 million when the firm collapsed in 2019.
How much risk do retail bonds carry?
Crucially, neither type of retail bond is covered by the Financial Services Compensation Scheme (FSCS), so investors have no protection if something goes wrong. If the bond issuer collapses, for example, not only will you not receive that juicy coupon but you could lose all your initial investment.
Jason Hollands, from the wealth manager Evelyn Partners, says: “These bonds might appeal to income investors looking for a better return than cash but without the volatility typically associated with equities. They can also help diversify a portfolio that is heavily weighted towards shares. But it is important to understand that access bonds are not risk-free and not a straight swap for a savings account.”
Those considering an access bond should do their research. Similar to choosing company shares to invest in, consider: how financially robust is the firm, what is the outlook for the business, and how much debt does it already have? Also just like stocks and shares, diversification is key. Don’t concentrate too much of your money in a single bond.
Make sure to understand where bondholders rank in the list of creditors if the company fails, and consider whether the coupon is enough to compensate for the risk. Hollands says: “Higher yields reflect higher risk. If an access bond is offering materially more than a savings account, that is because you are taking on additional credit and market risk.”
While the rebranding of retail bonds to access bonds indicates how the industry is taking steps to make these assets more suitable for investors, many experts remain sceptical.
Dennehy says: “These products have a scary mismatch between the attractive headline offer and the complexity and risks inherent in the underlying product.” While access bonds can be traded before maturity if you need your money back, he warns that because the market is so small, there is no guarantee you would actually be able to sell your investment if you needed to. Even if you are able to sell the bond on the secondary market, a lack of buyers could mean you receive a much lower price than you paid.
What are the alternatives to retail bonds?
Investors seeking regular income could consider a corporate bond fund instead. These hold dozens of bonds, chosen by an expert manager, which spreads your risk in the event that one defaults. Corporate bond funds focus on debt issued by companies, while strategic bond funds hold a mix of company and government debt, depending on where the manager thinks the best opportunities are.
Darius McDermott, founder of FundCalibre, likes the Liontrust Sustainable Future Monthly Income Bond fund, which invests in debt issued by the likes of HSBC and Severn Trent as well as UK government gilts. It yields 5.3%.
He also likes Artemis Global High Yield Bond, which invests in debt issued by Tesco and Aviva, among others, as well as US Treasuries and UK Gilts. It yields 6.51%.
Gilts are another option for income-seekers. This is an IOU issued by the British government and, while the interest paid is often lower than other bonds, the chance of default is minimal. You can access gilts through a fund such as the iShares UK Gilts All Stocks Index fund. It is also possible to buy them directly, which can have tax benefits – but be sure to check the rules.
Finally, if a guaranteed income is your priority, don’t overlook fixed-term savings accounts. MBNA currently pays 4.36% on its one-year savings bond, Market Harborough Building Society offers 4.75% on a three-year bond, and Chetwood Bank pays 4.5% on its five-year bond.
