The bond that could pay you 12% a year

If you're looking for an income stream to beat inflation, there's not much choice. High yield shares are one; bonds are another. And this retail bond could give you 12% a year, says Bengt Saelensminde.

I'm on a mission to bring you the best income strategies that I can find.

Today I'll show you how you could get a 12% annual return on your money. What's more, you can lock in that rate until the end of 2018.

Sound good?

OK. I know what you're thinking. There's no way that's possible no one can guarantee that.

That's true no investment is guaranteed to safeguard your money and make it grow. But trust me on this I think this is as good a way to earn a solid income on your savings as you'll find.

The overlooked asset class you should be using

The equity market is all over the place. At the same time, income on cash has hit rock bottom. But there's one area of the market that should be of great interest to investors. And yet most private investors completely miss it.

I'm talking about bonds.

Unlike equities where, largely speaking, holders are totally unprotected with bonds you can get a lot more security. You can buy them just as easily as shares and many of them can be held in an ISA, too.

So today I want to show you what I think is a cracking deal in the bond market. If you've got a portion of cash you want to earn you an income, I think this could prove a great choice.

The bond I want to look at is the Enterprise Inns 6.5% December 2018 (ISIN: XS0163019143). It'll currently cost you 75p to buy. That means instead of getting just 6.5% on your money, it'll be nearer 8.7%.

But it gets better yet.

At the end of 2018 you're promised £1 back for every 75p you shell out on a bond today. That gives you a capital profit of 25p for every 75p you put up. If you add that return to the running yield on the bond, you'll find that your annualised return is 12.1%. That's known as the gross redemption yield (GRY).

That sounds great. But you're probably wondering just how safe that is.

This £600m bond is backed by £1bn of assets

Enterprise Inns (ETI) is the largest pub landlord in Britain. A quick glance at its stock valuation and you'll see they're not highly regarded by the market. On a forecast p/e of less than two, investors are clearly sceptical.

That's fair enough. The pub game hasn't been easy over recent years. Worse, ETI has used many of its pubs as security as they've loaded up on debt. It's just like a homeowner with a massive mortgage.

But that doesn't bother me. I'm not interested in buying shares in the business after all, they're not even paying a dividend. I'm interested in their bonds.

And the generous terms extended to the bondholders are precisely why the equities are looking dodgy.

With a bond, as well as getting your interest payments, you get your money back at maturity. That means the issuer (ETI in this case) will need to find that money from somewhere. If they can't, then bondholders start to get nervous.

I think that in this case, the market has gotten a little too nervous. The point with this particular bond is that it's secured against a ring-fenced portfolio of pubs. If ETI can't pay back the bond, then they'll hand the keys (and rents) over to bondholders.

This from ETI's latest report and accounts:

"[We] expect to refinance the GBP600 million 2018 bond on maturity, bearing in mind that it will always be secured on a portfolio of pubs with an up-to-date valuation of GBP1 billion and interest cover of two times."

So based on a recent valuation, the pubs that the bond is secured against are worth £1bn. Given that the bond issue is for £600m, there's currently decent and tangible security for bondholders here. What's more, these pubs are currently generating revenue that covers the bond's interest twice-over!

What you need to know about the risks

Now what more do you want? The equivalent of 12% a year for nearlyseven years. And you'll have a mortgage over a portfolio of pubs owned by Britain's largest pub landlord. I love it.

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Sounds good, but of course there are always risks. As bondholders we want a fixed income. We don't want to become pub landlords! And anyway, if ETI can't afford to pay bondholders back and things get messy, there'll doubtless be costs involved with realising the value of these assets.

And remember, the valuation on the pub estate could go down. If pub revenues fall, then the valuation on the pub will likely follow. But then again, on ETI's figures they'd have to fall 40% before we start to get nervous.

The yield (and security) we're getting tells us that some investors are worried. We shouldn't ignore that. That's why I'd only advise putting a proportion of your capital into a bond like this.

Though I think this bond is cheap, remember it can always get cheaper. Like stocks, these bonds trade in the open market. If you want to cash out before 2018, you may get back less than you put in. On the flip side, if I'm right and investors warm to the bond, you could cash out early for a profit.

Don't ignore the bond market

So I wouldn't go 'all-in'. My point is that you shouldn't ignore bonds. They can be a great way to make your money work, especially when interest rates are near zero and stock markets are shaky.

What I'd do is build a diversified portfolio of bonds covering different maturities and different sectors of the market. That way, you spread your risk. This ETI bond looks to me like a good one to start with.

If you're looking for a secure income stream to beat inflation then there aren't exactly that many options on the table. High yield shares are one. Bonds are a great alternative.

Just a couple of tips on buying bonds. Not all stockbrokers allow you to trade retail bonds. If yours doesn't, check out our broker comparison page to find one that will.

Oh, and as with most of these retail bonds, you can only buy this one in multiples of 1,000 with a minimum investment of £1,000. You can get more information on the bond by visiting the stock exchange's website.

Action to take: BUY Enterprise Inns 6.5% December 2018 bond

11-11-04-enterprise-bond

ISIN: XS0163019143
Currency: UK sterling
Current price: 75p
Minimum investment: £1,000
Further details: London Stock Exchange
Five-year performance: 2007 -2.12% | 2008 -29.08% | 2009 +10.08% | 2010 +6.35% | 2011 +18.35%

This article is taken from the free investment email The Right side. Sign up to The Right Side here.

Important Information
Your capital is at risk when you invest in shares - you can lose some or all of your money, so never risk more than you can afford to lose. Always seek personal advice if you are unsure about the suitability of any investment. Past performance and forecasts are not reliable indicators of future results. Commissions, fees and other charges can reduce returns from investments. Profits from share dealing are a form of income and subject to taxation. Tax treatment depends on individual circumstances and may be subject to change in the future. Please note that there will be no follow up to recommendations in The Right Side.

Managing Editor: Frank Hemsley. The Right Side is issued by MoneyWeek Ltd.

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