A LITTLE more than three years ago, the London Stock Exchange launched the Order Book for Retail Bonds (ORB) – a trading exchange to enable private individuals to invest directly in the bond markets.
The ORB offers investors electronic trading in bonds in manageable amounts of around £1000.
Already around 180 securities are available on the ORB, with issuers ranging from well-known names such as GlaxoSmithKline, BT, Marks & Spencer, Vodafone and the London Stock Exchange itself. The levels of fixed income on offer typically range between 4.5% and 6% – well ahead of the 3% to 3.5% currently available on a bog-standard corporate bond fund.
Yet the flurry of bond issues targeted at private investors via the ORB has been accompanied by issues that are not traded on markets such as the London Stock Exchange, including a recent five-year bond launched by The Jockey Club to finance the development of the Cheltenham racecourse, and a currently open five-year bond seeking the backing of investors from hospital and gym manager Nuffield Health, which is offering a tantalising 6% annual rate of fixed interest.
This week Australian renewable energy firm CBD launched a four-year mini-bond offering investors a fixed rate of 7.5%, to finance UK solar and wind farm projects.
Part of the allure of these different types of "retail bonds" is the prospect for private investors of cutting out the middlemen, namely professional fund managers, in the quest for income. However, the risks of investing in a single bond are of course inherently higher than doing so through a diversified investment fund.
Individual retail bonds are not covered by the Financial Services Compensation Scheme, so in the event that the issuer goes bust you could lose your money.
And unlike a savings account, the interest on the bond may be fixed but the price of the bond itself may fluctuate, so if you need to sell your investment prior to its maturity, you may not get back the capital you invested.
If you invest in a bond that is not traded on a recognised exchange you may also find it difficult selling your investment ahead of maturity altogether.
And while headline yields may be relatively gobsmacking, a general rule of the thumb should be that the higher the income on offer, the riskier the bond may be.
Because the retail bond market is still at an early phase of development, it is simply too early to assess the level of defaults – ie situations where bonds fail to fully pay back the amount investors have originally loaned them.
Another complexity is that even where a well-known business issues a retail bond, these are often issued by a particular part of the group such as a subsidiary, rather than the core business.
An example is the retail bonds issued by Tesco Personal Finance, the financial services business of the supermarket retailer.
This means it is important to look behind the headline name, and to have a clear understanding of where the bondholders might rank in the overall pecking order of getting back their money in the event that the business runs into trouble.
So in summary, while individual retail bonds may well have attractions, it is important to understand what you are potentially getting into if you invest.
If you do not feel confident in your ability to do this, then it may make sense to rely on the middleman, in the form of a professional fund manager, after all. The income will not be as high but neither will be the risks.
Jason Hollands is managing director of national wealth management group Bestinvest
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