What are retail bonds?
A bond is basically an IOU where an investor lends money to a corporation or government in return for a predetermined interest rate together with the return of the original investment amount at the end of an agreed term. Bonds are issued to allow the corporation to grow by investing the money raised into the business.
The rate of interest depends on the strength of the corporation that issued the bond. The riskier the investment the higher the interest rate.
Historically, bonds were available only to investment companies and pension schemes and known as corporate bonds but over recent years they have been available to the private investor and referred to as retail bonds.
Are retail bonds a good investment?
As with most investments there is an element of risk and the same applies to retail bonds. Although the interest rate is fixed at outset and may compare well with your local bank there is always the risk of the corporation defaulting (see the next section). Also, you need to be aware that there will usually be no capital growth on your investment as only the agreed interest rate is paid this means that your initial investment will be eroded by inflation.
Are retail bonds covered under the Financial Services Compensation Scheme (FSCS)?
Well this is where the is a bit of confusion as not all retail bonds are covered under the FSCS. Recently there have been an increasing number of mini-bonds launched that are unlisted and therefore not covered under the FSCS. Due to the greater element of risk these mini-bonds often carry a higher interest rate than ordinary retail bonds. The other negative issue is that mini-bonds cannot be traded and, therefore, the investor has to retain the investment for the full term offered.
Why are unlisted retail bonds issued?
It comes down to cost as unlisted retail bonds are cheaper to issue than listed retail bonds. This saving can then be used to increase the interest rate on offer and therefore more appealing to the investor. When retail bonds are issued it is important that they fully subscribed as failing to do this can reflect badly on the issuing corporation.
Can I include a retail bond in an ISA?
Under ISA rules the retail bond issuer must be listed on a stock exchange and many mini-bond issuers are not, and must have at least 5 years to run from the point you purchase it.
Why not just buy a corporate bond fund instead?
Corporate bond fund managers typically hold over 100 different bonds within their portfolio in order to diversify risk. By investing in a single retail bond you would expose yourself to the risk of default from just one company. You have to ask yourself why you would you do that? Do you fully understand the risks? Plus retail bonds are often poor value when compared to the institutional versions invested in by bond funds managers.
Conclusion
With interest rates remaining low for the foreseeable future investors are always looking out for better returns. Retail bonds may on the surface appear to be the answer but, as explained above, you need to look carefully at each offer to ascertain the risk, liquidity and tax advantages involved.