Benstead on Bonds: time for equal access to fixed income?

Greater access to corporate bonds would be good news for retail investors, argues Sam Benstead. 

Investing in the stock market has never been so cheap or easy, with slick mobile phone apps offering instant access to the world’s stock exchanges.

But access to direct bonds for non-professional investors is still limited – and so people like you and me are missing out on soaring yields, as well as what can be a safer part of the investment universe.

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While owning shares gives you the right to a company’s profits if they choose to pay a dividend, companies must pay their bond holders if they can afford to.

This means that owning bonds, particularly those of high-quality companies or governments, can be considered less risky than owning a company’s shares. Even if a company goes bust, bond holders may get some money back as they have a claim on the company’s assets. Shareholders get no such protection.

Currently, nearly all bonds are issued in minimum £100,000 denominations, meaning that only large investors can actually buy them. For bonds to be below this figure, issuers need to give a more detailed prospectus, as per European Union laws.

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More work here has meant less reason to offer bonds to retail investors, so laws rightfully meant to protect retail investors have also actually shut them out of the bond market. Of course, for all the lost opportunity, there could also have been products well swerved.

Even still, data from the International Capital Markets Association found that in 2000, nearly 90% of bonds issued across Europe had minimum investments of €1,000 but by 2018 90% of all bond issuances had a minimum of €100,000 investment.

But the Financial Conduct Authority is looking to change this and require just one set of disclosure rules for all bond denominations.

The FCA says: “Such a scheme may be to the benefit of all participants, issuers and investors alike, giving issuers a new additional source of demand for their bonds and by giving investors better access to corporate credit.”

Winterflood, the stockbroker, is arguing for companies with a premium stock market listing, such as those in the FTSE 100 index, to consider issuing smaller denomination bonds so that retail investors can participate in the bond market in a similar way to how they can in the stock market.

It says that outside the National Savings & Investment scheme, the UK has been poor at offering regulated fixed-income products to savers, which contrasts greatly with America where there is an active municipal bonds market.

It also highlights that most of the wealth in the UK is held by those over 65. It argues that this is a demographic where access to regulated, high-quality fixed income would be particularly valuable.

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My view is that greater access to fixed income from blue-chip companies would be good news. The most important reason is that investors could be able to lock in an income that could beat that from their bank accounts or cash ISAs, without having to turn to the riskier “mini-bond” world where smaller companies raise money.

However, as with shares it is just as important when it comes to bonds, particularly corporate bonds, that investors do their own due diligence and understand the risk that’s involved. This includes examining cash flow, debt and profits to gauge the bond issuer’s creditworthiness.

In addition, retail investors will need to know the difference between a corporate bond and savings bonds issued by banks. The latter is safer, due to £85,000 of your money being underwritten by the Financial Services Compensation Scheme. Whereas, with individual bonds if the company goes bust, you are likely to lose your entire investment.  

Currently, an index of investment grade bonds paying owners in sterling has a yield to maturity of just below 6.5%.

While investors can own such bonds via a passive or active fund, there are differences when you own bonds directly.

First, assuming you are going to hold the bonds to maturity, you do not need to worry about changes in the price. Your return, on an annualised basis, will be the stated yield to maturity as you will collect the coupon payments and the final principal when the bond matures.

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In contrast, the value of a portfolio of bonds held in a fund will change as bond prices change. Because the fund will continuously be buying and selling bonds, you never hold a bond fund to maturity to collect your promised yield. You can only get paid the distributed coupons and if bonds are held to maturity then the principal is reinvested by the fund manager.

However, if interest rates have peaked and we enter a new bond bull market, then funds will rise in value. In contrast, you will not see a gain if you hold an individual bond to maturity. You can, of course, decide to sell an individual bond before it matures, banking a capital gain or less depending on how markets move.

While the income paid may be lower in a bond fund, one advantage is that you own a diversified pool of bonds and no one issuer having problems will sink a portfolio. However, the likelihood that an investment grade bond will default is extremely low.

While it remains to be seen if retail access to bonds will improve, there are plenty of options for investors to buy direct bonds via the retail order book for bonds, from the London Stock Exchange.

These include corporate bonds from high street banks, as well as bonds issued by the UK government, known as gilts.

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Most investors are buying gilts, rather than corporate bonds, as yields for bonds maturing in the next couple of years have been greater than 5%, with no capital gains tax due when the bonds mature, and low coupon payments limiting the amount of income tax due. This has been a key trend among interactive investor customers, although many retail investors will prefer to access this market via diversified, professionally managed funds. We are starting to see these diversified funds crop up more frequently in our monthly best buys. But investors deserve choice and fair access. The most popular gilts are UNITED KINGDOM 0.125 31/01/2024 (LSE:TN24), UNITED KINGDOM 0.25 31/01/2025 (LSE:TN25), and UNITED KINGDOM 0.75 22/07/2023 (LSE:TG23). The most popular corporate bond at the moment is ENQUEST PLC 9 27/10/2027 (LSE:ENQ2), from oil firm Enquest.

There is lots of work going on behind the scenes at interactive investor to make it easier to find and assess bonds available to retail investors. Watch this space – I’ll write something introducing the new features when they arrive and how investors can use it to pick bonds.

While we will have to wait and see if the FCA changes the rules around retail access to fixed income, it is certainly a hugely exciting time to be buying bonds, and especially gilts due to their high yields relative to other government bonds and tax benefits. Whether recent developments prove to be a game changer remains to be seen due to the levels of sophistication required when it comes to the often complex world of fixed income. 

I’ve written a complete guide to investing in gilts here, if you’re looking for more information.