Benstead on Bonds: reforms could be a game changer for retail investors

One of the biggest trends we have seen on our platform over the past couple of years has been the rise of direct bond purchases.

Spurred by higher interest rates and therefore higher yields available, a little under 4% of our platform assets under administration (at £77.5 billion as of the end of 2024) was invested in direct bonds, with most (more than 90%) of that going into gilts. This compares with just 0.9% of assets in direct bonds five years ago.

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Gilts are easy to trade for regular investors as they redeem in £100 units and there is a very liquid secondary market. We’ve also introduced access to auctions this year, meaning DIY investors can buy UK government debt at issue alongside large investors.

But buying individual corporate bonds, where yields are greater than on gilts to compensate for the extra risk, is still cumbersome for retail investors. The London Stock Exchange’s Order Book for Retail Bonds (ORB) is meant to provide some access, but the reality is that there are a limited number of high-quality bonds, in some cases with poor liquidity, making it difficult for investors to buy and sell.

However, that could all be about to change. The Financial Conduct Authority (FCA) wants to introduce new rules around how companies issue debt, so that it’s less onerous to include smaller investors in the process.

Undergoing a consultation process with the industry over the next couple of months, the FCA has proposed a number of regulatory changes. These include a single standard for bonds for retail and institutional investors, guidance on which bonds are suitable for retail investors and “non-complex”, and creating a simpler issuing process for bonds.

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If successful, the FCA expects implementation by the end of 2025 or early 2026. While it would be a “big bang” moment for retail access to corporate bonds, it is actually a return to what fixed-income investing looked like in the past.

Winterflood, the investment broker, calculated that between 2000 and 2004, two-thirds of non-financial corporate bonds had denominations of under £2,000 and there were 1,500 bonds available to retail investors before the regulation changed in 2005 and made the paperwork required for retail bonds even more complex.

Winterflood said: “Pre-2005, the use of low denominations, and access to the secondary markets, enabled retail involvement in the bond markets. Post-2005, retail access to new issues was curtailed as issuers began using high denominations to avoid retail disclosure requirements. Retail investors retained access to a (diminishing) pool of low-denomination bonds and with the inception of the London Stock Exchange Order Book for Retail Bonds (ORB) platform around 2011, a limited number of retail-targeted bonds.”

Access to investment-grade bonds from leading companies would increase the investment tools that retail investors have at their disposal.

This is because they offer greater yields than gilts, without much extra investment risk. The “spread” (excess return over UK government debt where the default risk is effectively zero) for sterling corporate bonds, is about 1% above gilts currently. The MSCI GBP Investment Grade Corporate Bond Index yields 5.2%.

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This is a meaningful increase in yield, for minimal additional risk. S&P Global calculates that default rates on sterling investment-grade corporate bonds have averaged 0.04% per year since 1991. There has not been an investment-grade default in the UK since 2009, according to S&P.

Nevertheless, diversification is still important and it would be sensible to own a range of corporate bonds.

Winterflood says that diversification will be feasible over time. Based on pre-2005 lower-denomination bond availability, the broker thinks that investors would have had access to 108 bonds across 16 sectors, if the rule changes had been implemented two years ago.

While investors can already own corporate bonds via a fund, owning the bonds directly gives a very different result to owning a fund.

Investors who hold a direct bond to maturity don’t have to worry about swings in its price, as twice-yearly coupons are paid and principal (amount borrowed) returned once the bond matures. On the other hand, a bond fund never matures, so its daily market value will be a key determinant of your holding period returns, rather than just the yield on the fund.

The difference shows that education around bonds is key to the success of these FCA changes.

I think there are a few points to get across to investors new to the world of bond investing.

One is that, if a company has publicly traded shares and bonds, then the bonds are way more secure than equities. In industry-speak, they are more senior in the capital structure of a company, meaning that if a firm runs into financial difficulties, while a company’s shares may fall in value and the dividends could be cut, it is still likely to keep paying its bond holders. While in such an environment a bond’s price may drop in value on the secondary market, it will still likely return to the redemption value as they near maturity.

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This brings me on to bond pricing. While bond prices can move in a similar way to equities, such as if a company is facing financial pressures and the likelihood of default rises, they are also very sensitive to the economic environment.

The big factor that impacts bond prices is interest rates. This risk-free borrowing rate is set by each country’s central bank. When rates go up, or investors expect rates to go up, it means that investors can get a better deal from newly issued bonds. This means that the prices of existing bonds may have to fall to bring yields in line with market rates. The reverse is also true if interest rates are falling.

Sam Benstead is Education Lead for the Investor Access to Regulated Bonds lobby group, which is involved in improving retail investor access to fixed income.